Modern Monetary Theory: A Track Record of Accurate Predictions and Insights
Modern Monetary Theory (MMT) has been a topic of debate and discussion among economists, policymakers, and the public for several years now. While some view it as a revolutionary approach to understanding the economy, others remain skeptical of its merits. However, when we examine the historical evidence, MMT has consistently provided accurate predictions and insights into various economic phenomena. In this article, we delve into the instances where MMT has proven to be correct, demonstrating its relevance in the ever-evolving economic landscape.
MMT's Stance on the Dangers of Borrowing in Foreign Currency: The Euro Crisis of 2008
Orthodox economics claimed that borrowing in one's own and foreign currency would lead to crises. MMT, on the other hand, argued that borrowing in a foreign currency relegates a country to the status of a household or firm whilst issuing debt in one's own currency is safe. The Euro crisis of 2008 demonstrated the validity of MMT's stance, as countries that borrowed in their own currencies fared better than those reliant on a common currency.
US Financial Deregulation and the Clinton Surpluses: A Recipe for Crisis
MMT economists such as Randall Wray and Stephanie Kelton criticised the financial deregulation policies of the Clinton administration, such as the repeal of the Glass-Steagall Act, which allowed commercial banks to engage in risky investment activities. They warned that these policies would create a financial bubble and instability and ultimately lead to a crisis. MMT economists also opposed the fiscal austerity measures of the Clinton administration, which resulted in budget surpluses from 1998 to 2001. They argued that these surpluses drained the private sector of income and savings and forced it to rely on debt and asset bubbles to maintain spending. They predicted that this would cause a recession and deflation.
MMT's Prediction of a Major Global Recession in the Early 2000s
In line with their criticism of the Clinton administration's policies, MMT economists foresaw a major global recession in the early 2000s. Their predictions were proven correct when the dot-com bubble burst, and the US economy entered a recession in 2001. This recession was further exacerbated by the events of September 11, 2001, and the subsequent war on terror.
Public and Private Sector Debt: The Great Recession of 2008
During the Great Recession (or Global Financial Crisis), orthodox economics focused on public debt as a 'grave' problem, while private sector debt was largely ignored. MMT emphasised that public debt is an asset to the private sector and a non-issue for a currency issuer, whereas private debt can lead to a recession. The Great Recession proved MMT right, as high levels of private debt were a major contributor to the economic downturn.
Greece's Austerity Measures: A Failed Approach
Orthodox economics blamed Greece's problems on profligate spending, suggesting austerity as a solution. MMT, however, believed that Greece's problems stemmed from austerity and that lowering long-term rates would enable the country to continue deficit spending to support employment. By 2020, the European Central Bank (ECB) kept rates low for Eurozone countries, and no debt crises emerged even though debt levels were higher than in 2011.
US Fiscal Restraint and Austerity: An Unnecessary Burden
In 2011, orthodox economists insisted that the US must exercise fiscal restraint and reduce spending to avoid excessive debt, which could hinder deficit spending during crises. MMT argued that debt was not a problem for the US and that austerity was not necessary for deficit spending during crises. In 2020, the US experienced a record-breaking deficit, yet the cost of debt (interest rates) fell, and no sovereign government faced issues rescuing the private sector.
Government Borrowing and Private Investment
Before 2008, orthodox economics claimed that government borrowing would crowd out private investment. MMT countered by stating that government deficits financed by money creation or bond issuance would “crowd in” investment as the private sector's balance sheets improved. In 2020, MMT's prediction was validated as there was a significant increase in incomes and a significant decrease in poverty.
Monetisation of Debt and Inflation
Prior to 2011, the orthodox view was that monetising debt would lead to runaway inflation. MMT posited that quantitative easing (QE) would have little impact on inflation, as it merely swaps banks' assets without affecting their ability to lend. The 2008 and 2020 instances of the increased money supply without corresponding inflation supported MMT's claim.
Deficits and Inflation
Before 2008, orthodox economics considered deficits to be inflationary. MMT argued that deficits were endogenous and responded to the demand for safe state money in recessions. In 2020, MMT's perspective was proven correct as the deficit increased, balances of US transaction accounts rose, and inflation fell.
Inflation and Economic Growth
In the pre-2008 era, there was a widespread belief that inflation was a major threat to the economy and that it had to be fought at all costs. However, MMT understood that mild inflation does not necessarily lead to a decrease in real output. On the other hand, actively fighting inflation can result in a drop in real output and lead to unemployment, which can be more harmful than inflation itself.
The 2008 financial crisis resulted in many countries adopting austerity measures to combat high levels of debt and inflation. Greece was particularly hard hit by these measures, with its economy falling behind that of Turkey, despite Turkey having high levels of inflation.
Addressing Inflation: Interest Rates vs. Root Causes
Before 2020, orthodox economics maintained that inflation could be cured by interest rates. MMT, in contrast, advocated addressing the root causes of inflation, such as supply-driven factors, and building capacity instead of increasing unemployment. Higher interest rates do not address any root causes. In 2020, when central banks in Europe raised rates, inflation driven by external factors like energy costs, food shortages, and logistics persisted, as highlighted by this Forbes article and, more recently, this one from the Australian Financial Review.
Conclusion
Throughout the years, MMT has consistently offered accurate forecasts and insightful analyses of economic events and trends where mainstream schools of thought have failed. MMT has demonstrated its value as an economic framework and deserves recognition not just as an alternative theory but as the successor ready to replace outdated dogma.
Whilst mainstream and other economists may sporadically grasp events and make accurate forecasts, only MMT has stayed a step ahead. It is crucial for policymakers and economists to consider the insights of MMT in order to develop effective strategies for navigating economic challenges and promoting sustainable, equitable prosperity.
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Well done, Darren. Very well done!