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Modern Monetary Theory – thoughts from our Group CIO

In our view, Modern Monetary Theory (MMT) is a great idea that could either work wonders or lead to disaster if poorly executed. Learn more about why it is especially relevant for investors these days.

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Summarising Modern Monetary Theory (MMT) is no easy task. Put simply, MMT argues that public debt will never be an issue, as long as the state can print the same currency in which it borrows and that the money is well spent.

Why is it relevant right now? 
With traditional monetary policy in most developed economies exhausted, we believe that world policymakers will turn to non-conventional policy measures during this decade in order to stimulate activity. In particular, monetary policy could be systematically coordinated with fiscal policy as proposed by MMT. The Covid-19 pandemic has dramatically accelerated this inescapable trend. Faced with the extreme urgency of fiscal support for the private sector, even governments most resistant to the use of fiscal policy have abruptly changed course now.

Before that, the Fed used to operate with a double mandate: slightly positive inflation at around 2% on the one hand, and full employment on the other. This monetary approach sought a trade-off between the health of the labour market and inflation.

Going forward, the Fed will allow inflation to slightly exceed the target level of 2% if this level has not previously been reached. With regard to the objective of full employment, the Fed is making its approach more flexible too by indicating that it will also take into account the level of underemployment of population categories in addition to the general level in order to assess whether monetary tightening or easing is necessary.

Capacity utilisation is key
In MMT, the constraint or limit on government spending, lies in the capacity utilisation of a country’s productive capacities and not on some self-imposed public debt limit.

The effectiveness and appropriateness of stimulating demand through a recurring public deficit therefore depends on the availability of unused productive resources and the ability to put them to good use. If the quantity of consumable goods and services does not increase but the stock of money that buys them does increase (for example through universal income for all), then prices will rise but wealth will stagnate. The resulting inflation is an indirect tax on savers and triggers a redistribution effect.

Inflation is at the heart of the debate   
Some might hear warning bells ringing in their ears and fear hyperinflation when they learn that governments could print their own money in order to support the economy.

Managing the risk of inflation is critical and MMT takes this issue very seriously. More than any other economic theory, MMT puts inflation at the heart of the debate and it offers a broader and more sophisticated range of techniques for managing inflation.           

Proponents of MMT insist that deficit financing is not a problem as long as deficits do not lead to inflation. They are most likely right, but it all depends on managing deficits and their composition in order to maximise the non-inflationary use of productive resources. In this respect, the nature of government expenditures is crucial.         

Lastly, the latest move by the Fed has implicitly asserted that inflation is not a problem in the short and medium term. Inflation will eventually come, but it will take several years and will not happen overnight.

Governance is the real issue          
If productive resources are not fully used because of recurring insufficient internal and external demand, or if available resources are not put to productive use because their capabilities do not meet internal market demand, MMT states that the public sector can compensate this shortfall in demand with deficits to support activity.

A strong education system that trains a seasoned workforce in new technologies and life sciences is a major advantage when implementing MMT.

Yves Bonzon, Group Chief Investment Officer

Over the long run, however, everything will depend on how the state allocates its support, under what conditions and through what mechanisms. In any case, it is important to allocate money efficiently.  

Unfortunately, the problems do not stop here. The issue of choices and preferences in the areas targeted by the state arises immediately. This is a matter of political preferences and redistribution among citizens.

It is important for investors             
Of course, the ability of countries to sustain fiscal deficits varies greatly. It is more necessary than ever for investors to focus their investments on countries with political systems that guarantee an efficient allocation of public money over and above the capacity to print the currency in which they borrow.

In addition, a strong education system that trains a seasoned workforce in new technologies and life sciences is a major advantage when implementing MMT. All this must be driven by a political system that has proven its worth, including in the area of checks and balances. The list of candidates is short.

In our view, MMT is a great idea that could either work wonders or lead to disaster if poorly executed. As with all ideas, its success is dependent on the quality of the execution. It is about governance and capital allocation by the state – a tall order indeed.