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Opinion

Modern Monetary Theory threatens revolution in economic thinking

Proponents advise printing money until inflation hits and approve of Abenomics

Does the Japanese experience validate MMT?   © Reuters

Japanese leaders have, in the past, often railed against public criticism of their policies by overseas economists. Never before, though, have they issued strongly worded rebuttals of foreign praise. Yet this is what happened when Professor Stephanie Kelton of Stony Brook University voiced her approval of government economic policy during her recent visit to Japan.

Professor Kelton is an advocate of Modern Monetary Theory, known as MMT, a heretical challenger to mainstream economics, which maintains that the only constraint on public spending is inflation.

In fact, the theory goes, there is no need for government spending to be financed by bond issuance at all. The central bank can simply create as much money as it likes until inflation becomes a problem.

Many supporters of MMT view Japan's "Abenomics" as a case study that bolsters their argument because it appeared to break with the orthodoxy of "austerity" and adopt an aggressively pro-growth policy mix, despite Japan's enormous pile of public debt. And that is exactly why the Japanese establishment has reacted as if being outed as members of some wacky cult.

Finance Minister Taro Aso called MMT "an extreme idea and very dangerous because it would weaken fiscal discipline" and Bank of Japan Governor Haruhiko Kuroda expressed "no sympathy whatsoever" with the theory.

The reaction among mainstream economists overseas has been similarly hostile. According to Larry Summers, MMT is "the voodoo economics of our time." Kenneth Rogoff calls it a threat to the entire global financial system. Even Bill Gates dismissed it as "crazy talk."

Apart from important theoretical differences about the nature of money, the naysayers' main objection appears to be the risk of hyperinflation, as experienced by several Latin American and African countries, if the government prints huge amounts of money.

Stephanie Kelton, a professor at Stony Brook University and an advocate of Modern Monetary Theory   © Getty Images

Professor Kelton is a former adviser to Bernie Sanders, the veteran left-winger once more seeking nomination as Democratic Party presidential candidate. A much younger radical American politician, Alexandria Ocasio-Cortez, has expressed her interest in MMT.

The theory has obvious attractions for the left because it seems to offer the prospect of limitless and costless public spending. In fact, though, it is closely linked to the "helicopter money" proposed by free-market enthusiast Milton Friedman as a cure for deflation and more recently considered by Ben Bernanke before he became governor of the Federal Reserve in 2006.

Such money need not be spent by the government. It could be simply mailed to citizens to spend as they like.

Indeed, there is another potential recruit to the MMT cause on the other side of the American political spectrum. On the campaign trail in 2016, Donald Trump declared that the U.S. government would "never have to default because you print the money" -- which is a central tenet of MMT. While mocked for this, the president was perhaps just anticipating the next turn in economic theory.

Does the Japanese experience validate MMT, as Professor Kelton implied? Perhaps. It certainly raises serious doubts about the "fiscal discipline" strongly advocated by Kenneth Rogoff, Christine Lagarde and many other experts and policymakers since the global financial crisis of 2008.

For Japan has been running large fiscal deficits for more than 20 years and has consequently amassed a Mount Fuji-sized pile of outstanding government debt, equivalent to 250% of Japanese GDP, according to Japan's Ministry of Finance.

Far from triggering a bond market rebellion and soaring interest rates, as doomsters consistently predicted, Japanese interest rates have fallen to vanishing point.

Since the start of Abenomics in 2013, the story gets even more interesting. Thanks to the quantitative easing program of bond purchases introduced by Kuroda, 40% of all outstanding Japanese government bonds now sit on the BOJ balance sheet.

In other words, one arm of government owes a vast sum of money to another arm of government -- which means that no debtor-creditor relationship exists. Despite the strident disclaimers of the Japanese authorities, this is not far removed from the world of MMT.

Having said that, the major cause of Japan's public deficits was not fiscal expansion, but the collapse in tax revenues that happened during the two "lost decades." In the first year of Abenomics, the government did increase public spending and the economy rebounded and inflationary expectations soared accordingly.

Since then, however, fiscal policy has been tightened. With one unnecessary and counterproductive tax hike being followed by another this autumn, it is no surprise that inflationary expectations have collapsed.

Japan's sales tax rate rose from 5% to 8% in April 2014: with one tax hike being followed by another this autumn, it is no surprise that inflationary expectations have collapsed.

Before the global financial crisis, Japan's rock-bottom interest rates appeared to be a bizarre and unique phenomenon. No longer. Now there are over $12 trillion of negative-yielding bonds in the world, including some corporate bonds.

In many countries the stimulatory effect of lower interest rates has already passed the point of exhaustion, raising the question of what governments will do to counter the next recession.

What the markets are saying they should do is clear -- take advantage of these unprecedentedly low interest rates to issue boatloads of bonds and pump money into their economies.

The Austrian government has just launched a tranche of its 100-year bond at an interest rate of 1.2%. Judging by the comparative yields of their 30-year bonds, Japan could probably borrow 100-year money for less than 1%.

Instead of raising taxes on consumption and damaging growth, Japan could be investing in infrastructure, clean energy and fertility incentives that would increase the expected population and revive sadly depopulated regions.

Not every country is in the same position as Japan, which is the world's largest creditor nation and has been clocking up current account surpluses since the early 1980s. But it is fairly clear that in many countries a combination of monetary easing and fiscal expansion, as well as tax reform -- not hikes -- is required to revive growth.

If mainstream politicians and technocrats do not rise to the challenge, then the populists will fill the gap. And that could be dangerous because MMT has so far had little to say about the varying financial conditions of different countries and the magnitudes of stimulus that are required for the remedy to work.

It is all too easy to imagine circumstances in which countries that are, unlike Japan, already under-saving and over-consuming go too far and end up with a serious inflation problem.

Peter Tasker is an analyst with Tokyo-based Arcus Research.

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