Modern monetary theory (MMT) argues that, rather than central banks printing money to buy financial assets, governments should create money to directly fund public expenditure or tax cuts.This is sometimes referred to as a “helicopter drop”, a term coined by American economist Milton Friedman, or “helicopter money”. Some call it “people’s quantitative easing”.
Here’s what Keith Wade (Schroder’s chief Economist) had to say on the approach and the potential implications for investors.
Why all the talk of helicopter money and “modern monetary theory”?
It is clear that government borrowing is set to rise significantly as a result of the Covid-19 pandemic and this will put tremendous pressure on public finances. Government debt to income levels are already high in many economies as a result of the global financial crisis but now look set to rise significantly higher. In this environment, the idea of financing spending through printing money rather than issuing bonds becomes very appealing.
How does it work?
The key difference between quantitative easing and MMT is that the central bank prints money which is fed directly into the economy, either through tax cuts or increased spending, rather than by buying assets.
Consequently, it would have a more immediate effect in boosting demand rather than waiting for higher asset prices to feed through to the economy. It also avoids the criticism of QE that it increases inequality by supporting wealthy asset holders.
What are the dangers?
On the downside, it is potentially more inflationary. This is in part due to its more direct effect on activity, but mainly because the government does not have any future liability in the form of bond issuance where the bonds have to be repaid at some point in time. Therefore it undermines fiscal responsibility.
Hence MMT is a policy more often associated with failing states than with developed economies and, unless done within prescribed limits and seen to be temporary, would result in a ratings downgrade for the government’s debt and higher interest rate costs.
Are we close to seeing MMT in action?
Arguably governments have already done some MMT as little of the QE has been reversed and the interest generated on the assets has been fed back to the exchequer, which can then be used to fund spending. So perhaps they are getting away with it. Ultimately it’s a matter of scale: MMT in Germany led to hyperinflation during the 1920s, but they printed multiples of GDP as the fiscal position was already undermined.
What are the implications for investments?
If accompanied by a loss of fiscal discipline, MMT would make investors concerned about higher inflation. Bond yields would rise significantly as investors demanded more compensation for higher prices in the future. This in turn would have an adverse effect on risk assets such as equities which would de-rate (i.e. price/earnings ratios would fall) as bond yields rose.Keith Wade