This leads to a provocative conclusion that monetary policy cannot control inflation but can only control interest rates, which poses a major challenge to modern central banking practices that emphasise the price stability mandate and central bank independence. This means that the objective of monetary policy should be shifted solely to making fiscal policy as effective as possible – the conventional active role of stimulating/containing aggregate demand and inflation. Maintaining the low interest rate is conducted by an open market operation with commercial banks using government bonds. Regarding the role of monetary policy, MMT emphasises that a central bank should support fiscal policy by maintaining interest rates at around 0% persistently and passively to maximise the effectiveness of the fiscal policy. This feature could prevail if increased government spending raised reserve balances and place downward pressure on market interest rates. Another distinctive feature of MMT is that expansionary fiscal policy lowers interest rates rather than raising them – contrary to the widely shared view of the crowding-out effect in the loanable funds market. In contrast, the government is able to increase employment directly by conducting various public projects. Some of these points – especially those related to the effectiveness of monetary policy – seem to partially align with the fact that unconventional monetary easing conducted by major central banks after the Global Crisis generated disappointing results in terms of addressing aggregate demand, inflation, and long-term inflation expectations. Third, monetary easing tends to promote an accumulation of private sector debt and thus reduce private sector net wealth, as mentioned below. Similarly, monetary tightening or an interest rate hike in an expansionary phase does not necessarily contain credit growth and excessive inflation if domestic demand could be boosted by increased interest income. For these reasons, a negative interest rate policy is dismissed by MMT. A cut in interest rates also promotes an unfair transfer of interest income from creditors to debtors, causing distortions in income distribution. Second, a cut in interest rates could be economically contractionary, since reduced interest income discourages active private sector spending. The most salient feature of MMT is that fiscal policy is effective while monetary policy is ineffective for several reasons.įor starters, monetary accommodation or a cut in interest rates in a downturn does not necessarily generate sufficient private sector demand for credit when the outlook on firm profitability and household income remains weak. Salient features of MMT: The dominance of fiscal policy over monetary policy Taxes are not only treated as an inflation adjustment tool, but also used as a tool to increase public demand for the currency. MMT holds that expansionary fiscal policy can be sustained until substantial inflationary risk emerges, which in turn could be controlled through a tax hike. Thus, government should increase public spending in the correspondent domestic currency – namely, reserve balances of designated financial institutions with the central bank – to achieve full employment as an employer of last resort and price stability without worrying about rises in the fiscal deficit and public debt.2 As the government is never financially constrained, neither taxes nor bond issuance to the market are necessary in order to finance public spending. It claims that governments never default on their own currency-denominated debt because the monetary sovereign government is the monopoly supplier of its currency (for example, Tymoigne and Wray 2013). MMT is consistent with the pro-fiscal policy view, but provides unique views about the role of government spending as well as zero-default risk on domestic currency-denominated government debt. Moreover, the global economic slowdown, rising relative poverty and inequality, and limited opportunity for additional monetary easing all support the case for fiscal expansionary policy. While MMT has been known for some time, it has recently captured a lot of attention after US Congresswoman Alexandria Ocasio-Cortez of New York stressed its importance to boosting public spending for education and medical services earlier this year.1The growing emphasis on expansionary fiscal policy reflects the disappointing performance of unconventional monetary easing – including lower-than-expected economic growth and inflation performance, as well as various adverse side effects. ‘Modern monetary theory’ (MMT) has become a much-discussed topic in policy recently.
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