This recent heterodox economic theory has many financial market participants spooked. I will try to explain what it entails (it takes some effort to understand) and the potential impact it could have on the various markets should it be put into practice, chiefly because it shifts our understanding of how the economy works (inflation, interest rates, debt, currencies, etc). Also, regardless of the fact that its strict implementation may turn out to be extremely complicated in real life, it is a good idea to try to understand what it is all about in the event that an attempt is made to partially adopt it. Fundamentally, it is an approach to economic management with no ideological basis. However, it is true that increasing numbers of economists with ties to the left are arguing in favour of putting it into practice.
MMT is based on two premises: 1) a country that issues its own currency can print money limitlessly without the risk of default; and 2) public spending is independent of financing and it has the ultimate goal of guaranteeing full employment.
The primary message being sent is that monetary policy makes little sense because it involves wasting real resources by associating it with high rates of unemployment throughout the cycle. Fiscal policy, therefore, is the centre of economic management for a country. Public spending should focus on maintaining full employment, while taxes should be used to slow the economy when necessary and to combat inflation. Furthermore, public debt would be used to manage money supply, interest rates and the level of capital investments. And this would all be with a floating exchange rate regime.
Inflation is seen as a consequence of having reached the country’s maximum productive capacity and, therefore, it marks the theoretical limit of public spending. In this case, a reduction to public spending or a tax increase would be implemented.
Why is this theory growing in support? My feeling is that, on the one hand, the world has gotten used to a model of continuous stimuli and, on seeing that QE has reached breaking point (we need only look at the mess in which the markets found themselves in the last quarter of last year due to fears about QT), at such a late stage in the economic cycle, the debate about turning the screw from a fiscal policy perspective is necessary for the political class. And on the other hand, MMT directly targets one of the greatest negative impacts of QE, the growing inequality at certain levels of society – another handy argument for the political class.
To try to discern the impact that MMT could have on the financial markets (and this is by no means an exhaustive analysis), we could start by looking at the large increase in public spending to meet the mandate of achieving full employment. This is public spending financed by printing money, which lowers interest rates. In this scenario, capital and financial investments would surge. The beginnings of inflationary pressures would start to be felt and the government would begin increasing bond issues to raise the interest rates. At some point, interest expenditure would exceed nominal growth. In all likelihood, inflation would not fall, so few investors would want this debt. A good many investors would go abroad, which would speed up a sharp devaluation of the currency and bring about the need to print yet more money. Here is where we would begin to see massive hyperinflation. As Minsky said, anyone can create money, the problem lies in getting it accepted.
The effects on debt and the currency are clear, but what about equities? It is obvious that because equities are real assets, they would behave better than nominal assets. But it may be better to invest outside the country, also in real assets, bearing in mind that the government’s need to raise taxes could even come to be considered confiscatory.
As I mentioned, it is good to consider that the application of MMT would, to begin with, mean the creation of a tax authority (similar to a central bank) that is independent of the government, something that seems very difficult. But, in any case, we can see partial efforts being made to put the theory into practice, chiefly through fiscal stimulus policies that are partially or fully monetised. Here it will also be important to invest in real assets (due to inflation expectations), such as the stock market, but by carefully selecting the securities with pricing power capacity.
Column by Luis Buceta, CFA. CIO Banco Alcalá. Head of Equities Crèdit Andorrà Financial Group. Crèdit Andorrà Financial Group Research.
For Alicia Miguel
For Fórmate a Fondo