You would have seen in the media many times about the huge sums of debt the Australian Government is racking up from the coronavirus stimulus package ($200 billion and counting). Conventional economic theory will tell you this is a bad thing, that it has huge implications for younger generations and their future as governments will need to ‘pay back the debt’ and therefore spend less money on public infrastructure and welfare, etc. in the future.
But what if we told you that the idea of a ‘national debt’ doesn’t have to be ‘repaid’?
An economic theory that was developed in the mid-20th century is gaining worldwide traction. It’s called the Modern Monetary Theory (MMT).
MMT in simple terms, says that a stalled economy is bad, but using government debt trying to re-stimulate that economy isn’t bad. Why? Because government spending is essential to starting the economy (paying for welfare, unemployment benefits, putting money into public transport, etc.) and they can essentially print as much money as they like.
This is exactly what happened recently; the ‘printing’ (money isn’t actually printed any more, it is generated digitally but the process is still called printing money as it used to be the case that governments would simply print more $100 bills to boost the economy) of more money, $200 billion of it. This is money that is typically known as a government deficit because it’s money that haven’t come from their usual revenue source: taxes.
They kind of work like this. The government issues a bond (borrows money) and promises to buy it back (repay the borrowed amount) from the buyer after a fixed period, plus pay interest. It’s effectively the government taking out a loan.
Central banks like the Reserve Bank of Australia (RBA) are special kinds of public institutions tasked with managing the supply of money in an economy. At times like these they buy government bonds that they issued (I know, it’s a bit of a mind twister) from banks and pension funds so that there is more cash in the economy. When banks have more money (cash), they can lend more readily to businesses and consumers, which in turns lead to greater spending, and ultimately more economic activity.
This leads to the question, where does the RBA get its money?
As part of managing the supply of money, central banks have a very special ability. They can issue legal tender — aka ‘print money’.
To buy the government bonds, the RBA issued itself billions of new Australian dollars.
MMT essentially says printing more money does not necessary mean it’s a bad thing. We like to traditionally think of the government being run like a household where we face budget constraints because of a limited income, but that isn’t true for currency-issuing governments, i.e. governments that can print their own money. A household needs to spend within its means, but governments can create money, so there is practically no limit.
Some argue that this is not prudent governance as the Government (or more to the point, the citizens) will have to pay back this debt at some point in the future. But since the interest rate is so low right now, this money is essentially free.
So why haven’t we used MMT already? There are a number of possible reasons, including concerns about its implication on inflation, that it may devalue the currency and cause economic chaos.
In the last 40 years, Australia has kept to spending only tax dollars, but having shown it can create money when it needs it, is it going to be a bit harder to justify future government cuts?
We are in uncharted waters and it remains to be seen how synchronised global government debt impacts the economy and business in general. Let’s hope MMT isn’t proven completely wrong as the alternative of a deep, long recession doesn’t sound very appealing for any of us.
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