Modern Monetary Theory

Livemint     10th February 2021     Save    

Context: Advocacy of Modern Monetary Theory (print money to achieve full employment and fund purchases) has been growing louder but whether it’s viable in a country like India is far from clear. 

Key Features of Modern Monetary Theory:

  • Challenges mainstream economic thinking: It challenges the view that government spending to support an economy is constrained by tax collections.
  • The ability to spend is based on monetary sovereignty: Any country that issues its own fiat current, and only borrows in that currency, is released from the concerns about how to fund a budget deficit.
    • E.g. The US prints the global reserve currency. Greece has signed away its monetary sovereignty to the European Central Bank
  • Claims that governments do not face any financial constraints but only real constraints.
  • Concerns about inflation: It climbs when the economy runs faster than its productive capacity.
    • Inflation can take hold if people hold too much money that they may spend, thus pushing up prices.
    • Inflations takes off only when resources are fully employed
  • Role of Central Bank: The central bank can provide the monetary support to make any level of government borrowing sustainable, at least till inflation begins to accelerate.
  • Based on Chartalism: It argues that governments create money so that citizens have the means to pay taxes; thus changes in tax rates are a means to either keep or take away more money from citizens.
  • The job of the fiscal policy is to ensure full employment, rather than maintain “sound finances”.

India specific challenges: which questions the viability of MMT in India.

  • Unprecedented high public debt: at 85.7% of GDP in 2025-26 (as estimated by 15th Finance Commission report) is due to recent fiscal expansion aimed at economic recovery.
  • Low Monetary sovereignty: While India mostly borrows in rupees. Yet, the country as a whole borrows from the rest of the world.
  • Financial constraints (neglected by MMT):India needs foreigners to buy domestic assets to get the dollars it needs to fund its current account deficit
  • Restricted role of the central bank: which acts as a price taker rather than a price maker in the global financial system. (since Indian interest rates are influenced by global rates).
  • Impact of tax rate changes: While the MMT supports tax rate changes, increased frequency of changes will affect long term decisions in households and firms.
  • Problems in labour market: in terms of informal nature, seasonal employment, disguised unemployment, low labour force participation and creating jobs outside agriculture.