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Modern Monetary Theory

For generations, undergraduates have been fed a steady diet of what might otherwise be called “traditional” economics – economic theory that is predicated on the plausible but largely unsubstantiated premise that people make rational decisions in their own economic self-interest.  That notion of economic self-interest, first championed by Adam Smith, is now nearly a quarter millennium old and there are a number of variants that come from it.  For instance, there are the ongoing debates between monetarists and Keynesians; debates between the so-called ‘salt water schools’ and ‘freshwater schools’ and debates between traditionalists and behaviouralists. Economics, the ‘dismal science’ isn’t really much of a science at all, given that economic theories implicitly recognize the influence of systems theory – where one decision will affect another and so on.  The idea of simple, measurable cause and effect testing is quaint in theory, but almost always impossible to replicate in practice.

 

A recent ideological variant is something called Modern Monetary Theory (MMT).  It’s an updated wrinkle on the traditional monetarist approach.  Historically, monetarists have posited that the role of central banks is twofold: to ensure both price stability and strong economic growth, as defined by something approaching full employment.  We all saw a proactive form of MMT in action in the U.S. late last year when, despite decades-low unemployment numbers and inflation that was well within the 2% target range (give or take 1%), there were three consecutive rate cuts implemented by Governor Powell. This was a clear attempt to avert a possible recession since the U.S. yield curve had inverted earlier last spring.

 

Lately, central banks have been hinting at the notion that we ain’t seen nothin’ yet.  Apparently, they are now prepared to keep rates low for a very long time (decades at least, but possibly generations) in order to keep more people working.  In essence, the twin monetarist objectives mentioned earlier have now been given a hierarchy.  According to MMT, full employment trumps benign inflation as a public policy objective.  As such, central bankers are now openly saying they will work to stimulate job growth even if it is somewhat inflationary and even if that inflationary trend creeps above the target range that has been in place for about three decades now.

 

My sense is that there’s a genuine fear on the part of bankers that economic growth is a remnant of the past.  I also suspect that politicians will love the new orthodoxy, because it gives them licence to spend like never before.  With interest rates near zero – potentially for the rest of our lives – deficit spending and the unprecedented accumulation of public debt is primed to be normalized. It’s a brave new world and no one really knows how this will play out in the years ahead.

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