The COVID-19 Pandemic: Is Now the Time for Permanent Monetary Finance à la Modern Monetary Theory?

Abstract

In response to the COVID-19 pandemic, G7 central banks have launched asset purchase programs in anticipation of an increase in government bond offerings to finance ballooning fiscal deficits. As the volume of government bonds owned by private investors is not expected to rise during the current crisis, these programs will amount to a monetization of large additional debt. The idea that the government sells bonds to the central bank also play a key role in Modern Monetary Theory (MMT) and the concept of so-called helicopter money. This article subjects key aspects of MMT to critical examination and shows, using MMT’s own balances sheet analysis, that the theory is almost always contradicted by the actual workings of the modern credit economy. First, MMT argues that central banks should permanently buy bonds from the government. But this way of financing government spending would come at the high price of giving up on monetary policy. While the central bank could pay interest on reserves to keep its power, this would be equivalent to government borrowing and would save nothing. Second, according to MMT, governments do not need to issue bonds to fund themselves. However, because MMT has given up on monetary policy, it is forced to manage the case of excess demand in other ways. It accomplishes this by altering the supply of reserves to banks through borrowing in the bonds markets, which in its theory leads to a change in short-term interest rates and thus dampens consumption and investment. However, this analysis is deeply flawed and disproven by the actual behavior of central banks. In real life, during and after a government bond auction, the supply of reserves remains constant, and hence short-term interest rates do not increase and can therefore not dampen investment and consumption in case of excess demand. Third, proponents of MMT overlook the political economy of permanent monetary finance in their endeavor to sideline central banks and to place the power to create, allocate, and spend money permanently in the hands of politically elected governments.