How can modern economic theory inform the recovery?

  • Explain the the current state of the UK economy
  • Identify the implications of high government debt levels
  • Describe how MMT differs from other economic strategies
How can modern economic theory inform the recovery?

As the UK endures a second lockdown and the furlough scheme is extended, our eye-wateringly high budget deficit is due to get even bigger.

While the various vaccine announcements will mean life begins to improve, the quantity of government spending to support the economic recovery will still be vast by any standards. 

If it is any consolation, the UK is not alone: governments around the world are doing all they can to tackle a second wave of Covid-19, keep people employed, and avoid a profound economic recession. Admittedly, this is no easy feat. 

Against this backdrop, Modern Monetary Theory (MMT) is getting an increasing amount of airtime.

It enjoyed a resurgence during Democrat Bernie Sanders’ presidential nomination campaigns, under the influence of his economic adviser, Stephanie Kelton. 

She is the former chief economist for the Democrats on the US Senate’s budget committee and one of the best-known advocates of MMT.

So how does MMT work? This economic theory proposes that governments with their own sovereign currency can spend freely without having to worry too much about the repercussions because they can always create more money to pay off their debts. 

The main limit to money creation is inflation. 

However, this only poses a challenge once the economy starts to operate at full capacity with full employment.

If or when this happens, advocates of MMT argue that governments can bring inflation under control by spending less and withdrawing money from the economy through taxation.

It is worth noting that the vast increases in the supply (quantity) of money in the decade since the global financial crisis did not lead to a sharp uptick in the rate of consumer inflation in the economy. 

The theory proposes that government spending alone can grow the economy to full capacity, eliminate unemployment, and finance initiatives that are typically considered non-essential, like infrastructure spending.

Pandemic priorities 

Looking back at the events of the past decade, it is easy to see why MMT has come to the fore.

We have been through a period of slow growth and interest rates have remained low for a long time. In many cases economies have not performed at full capacity, so deficits have not reduced all that much.

Fast forward to the spring of 2020 and suddenly MMT’s principles have taken on a whole new meaning, as governments grapple with the ongoing Covid-19 crisis and ballooning deficits. In this sense, MMT could be viewed as a modern way for governments to spend their way out of the pandemic. 

Now a second wave is under way, sparking a new round of national lockdowns, the chances of a V or U-shaped recovery are fast diminishing. 

It is possible we see a selective K-shape, where different parts of the economy recover at different speeds - for example, technology giants and their owners will expand their wealth, rising on the upward arm of a K-shaped recovery, but conditions for gig economy leisure, retail and hospitality workers will worsen as they descend the leg of the K.