The Modern Monetary Theory proposes the use of expansionary fiscal policy through money creation to pay-off huge fiscal deficits to maximize job creation and employment in the given region (Edwards, 2019). The theory relies on the ability of the expansionary policy to drive demand, which results in increased investment. MMT supporters also argue the strength of the policy to be the sovereignty of the local currency. Moreover, Edwards (2019) argues that its foundation is economic principles that people already know and implement. The essay writer continues to point out that the current controversy in its application is founded on the notions of overspending and increased deficit, principles, which the theory does not advance. However, Wray (2019) argues that there is limited empirical evidence that can aid in the implementation of the policy. In addition, the four countries that have implemented the proposition of the theory have invited adverse economic consequences. They include hyperinflation, the rapid growth of government deficit, and decline in real wage. The following is a discussion of the tenets of the economic consequences that Edwards (2019) and Wray (2019) use to shed light on its economic principles.
According to Edwards (2019), the four countries that have implemented the MMT have experienced or currently experiencing very high rates of inflation. Moreover, there is no clear framework in which to apply the proposed monetary policy. Very little empirical evidence is providing the medium and long-term effects of the policy. Moreover, the policy has an adverse economic impact on real wages in the medium and long-term. For instance, in Chile and Peru, real wages went down by approximately 39 and 41 percent, respectively, in the periods the policy is implemented (Edwards, 2019). Therefore, MMT only offers reasonable suppositions and economic conditions in the short-term; however, in the medium and long-term, it is unsustainable. Latin America has primarily implemented the theory and has resulted in negative economic consequences. For instance, in 2001-2002 in Argentina, unemployment skyrocketed by approximately 25 percent as the peso lost value by 80 percent. Criticism of the theory focuses on economic principles that propose increased money printing, which increases demand beyond productive capacity. It ultimately results in high inflation and depletes foreign reserves, which significantly affects the domestic currency.
According to Edwards (2019), the implementation and economic effects of its application take place in three distinct stages. The first stage is characterized by increased money supply, case in point, in Argentina, it increased by 124 percent. However, inflation by price controls control inflation directly (Edwards, 2019). In this phase, the government significantly increases transfer payments and public expenditure. In the second stage, the effects of the heterodox policies begin to show up in the economy. International currency reserves are significantly depleted, and the domestic currency depreciates significantly. The third stage is characterized by worsening economic conditions and deepening economic imbalances. The government initiates increased price controls and indexation to keep inflation low. However, due to high prices and depleted International reserves, inflation keeps rising. According to Edwards (2019), economic collapse and negative growth become a reality. For instance, towards 1989, Peru recorded a 9 percent negative economic growth. Therefore, the theory can only establish its sound economic effects in the short-term but adverse negative effects in the long-term.
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Edwards (2019) points out that a large government deficit is experienced in the immediate implementation of economic policies. For instance, in Chile, in 1973, the government deficit rises to approximately 25 percent of GDP. The increase in government deficit can be directly attributed to the rise in government debt expenditure and borrowing. He continues to point out that the creation of money and fiscal deficit leads to the low acceptance of the theory. Moreover, according to Edward (2019), the approach does not recognize the importance of the demand for money. In the presence of hyperinflation, financial institutions decrease their domestic holding significantly. Considering the Keynesian theory, people hold cash for three purposes, speculative, cautionary, and transaction motives. However, with the decreasing ability to utilize the money for three objectives, it significantly reduces the need for domestic currency. Case in point, In Chile in 1973, inflation surpassed 500 percent (2019). It is directly attributable to a decrease in local currency demand due to the depleted international reserve. Therefore, Edwards (2019) suggests that the exclusion of the centrality and importance of the demand for money is a definite weakness for theory.
The policy implementation of the theory has had significant effects on real wages and exchange rates. For instance, in Chile, salaries declined by more than 38 percent in a period of three years. In Peru and Venezuela, wages also reduced by approximately 41 and 21 percent, respectively, in almost a similar time frame (Edwards, 2019). The adverse effects of the policy even include the development of a black market for necessities, such as food. However, the wages and salaries in these countries are also affected by the existing financial conditions and the prices and quantity of exports. For instance, in Venezuela, the decrease was significantly lower than the two other countries as the price and demand relatively increased. The drop in real wages is attributable to presiding high employment beyond the production levels and the aftermath of very high unemployment rates. In Peru and Chile, the domestic currencies lost value by approximately 8000 and 93 percent, respectively (Edwards, 2019). The depreciation in the local currency exerted more pressure on the already compounding economic unrest. The theory, as it is based on the sovereign capacity of a country to print money, ignores the effects of foreign investors’ confidence on the monetary and fiscal policies of the country. Therefore, it leads to decreased investor confidence in the domestic currency, which ultimately depreciates.
Wray (2019) points out that the comments on the MMT by the Chairman of the Federal Reserve and the Prime Minister of Japan are misguided. The two argue that the implementation of the policy is not economically valid and dangerous. He claims that the theory is based on long-standing economic theory. MMT shows the importance of the three actors and the importance of their past, current, and future positions. For instance, the government being in a deficit means that businesses continues to enjoy a surplus. However, if the government seeks to reduce the debt, it will take out demand from the market. As such, the government can only reduce the deficit through taxes or reduced expenditure. Therefore, the government must maintain or increases its spending to ensure that the households and private sector experience surpluses. However, over the last three decades, government spending has primarily been constant. Case in point, government spending in the late twentieth century steadily declined and only rose as a response to the economic distress of the recession (Wray, 2019). After the economic downturn, the government spending to Gross Domestic Product has stabilized around 11-12 percent. Therefore, government spending has been part of the economy in both booms and recession to support the economy.
The Modern Monetary Theory allows for economists and policymakers to address the financial system from a different perspective. Economists and legislators view government deficit and debt as an unwanted condition. Therefore, they advocate for its reduction through taxes or reduction in government direct and indirect spending. However, MMT cautions on the complicated relationship that brings about government debt if reduced will be reducing economic growth. The MMT views the economy as an engagement by three participants- the government, private sector, and households. Therefore, at the general level of the economy, average expenditure must always equal average income. In case one of the parties in the economy spends in excess (deficit), one party will have to save the excess (surplus). In the case of the United States, the government more than its income, which, consequently, results in excess in the private sector. For instance, the government’s deficit has increased sharply during President Donald Trump’s administration due to increased tax cuts. The government public debt between 2017 and 2019 rose from 5.6 percent to 7 percent (Wray, 2019). In 2019, as public debt rose to 7% of GDP, the excess in the businesses increased to 4.63% of GDP (Wray, 2019). Therefore, the theory allows for economists and policymakers to view the general movement and effect of government debt. It sheds light on the constraint of the balanced budget that is proposed by Congress and economists. It advances the understanding that tax hikes and spending reduction will only result in a deficit of a similar amount to either the private sector or households.
Wray (2019) points out that modern monetary policy should be aimed at reducing debt in two perspectives lowering growth or net private sector surplus. Rather than emphasizing the need to reduce government debt per se, its reduction should only be viewed through its impact on the economy. It is also noteworthy to point out that high deficits and low deficits are correlated with both high growth and slow growth. Wray (2019), argues that governments should seek to reduce their debt obligations through austerity measures. However, even these austerity measures may end up increasing debt, depending on the reaction from the economy. The government can also choose to boost the economy through proactive fiscal policy. For instance, in instances of surplus demand, it could increase taxes and reduce transfer payments. As such, it removes the centrality of public debt, which does not indicate the level of economic performance, from policy formulation. Government debt has received significant controversy in the recent past. The theory assists in demystifying the full effects of increased and reduced debt ceiling and government spending. It also shows the importance of fiscal policy in driving and sustaining economic growth. However, it does not remove the importance of public debt management from the policymaking process.
The implementation of MMT has been criticized due to the negative empirical evidence in countries it has been applied. However, it is noteworthy to point out that it is based on sound economic theory, as illustrated by Wray (2019). Furthermore, it can explain the economic phenomenon of government deficit and the business cycle. However, its strength is limited to its theoretical underpinnings, and its implementation will remain mostly skeptical. MMT does a critical task of describing the importance and the relationship between government debt and the economy. The theory offers a new and vital view of government debt in driving and sustaining economic growth. However, due to its budgetary constraints and limited understanding, it has been mostly ineffective. Edward (2019) clearly provides evidence that suggests the theory is still largely underdeveloped and unsuccessful. Therefore, it will be challenging to implement in a more developed and critical economy, such as the United States economy. However, it offers excellent insights into the historical and future role played by government debt in controlling and facilitating the economy.
Edwards, S., 2019. Modern Monetary Theory: Cautionary Tales from Latin America. Cato, J., 39, pp.1-27.
Wray, L., 2019. CONGRESSIONAL TESTIMONY: Reexamining the Economic Costs Of Debt. Hearing before the House Budget Committee, 210 Cannon House Office Building, pp.1-30.