Monetary Policy

Modern Monetary Theory cannot deliver long-term growth, says new IEA research


In the Media

IEA research reported in the Asian Voice


Christopher Snowdon quoted in the Daily Mail

  • Although the response of the major economies to the Covid-19 pandemic falls short of adopting Modern Monetary Theory (MMT) policies entirely, there has been a shift towards MMT principles.

  • Since March 2020, central banks in major economies have been partially monetising government deficits by buying government debt through quantitative easing and other lending schemes.

  • In the UK, this resulted in a 14 per cent increase in the rate of money in the economy in 2020, which has escalated to 15 per cent in January 2021.

  • Had the UK adopted a full MMT policy, whereby the Bank of England financed all government spending, the annual rate of growth of money would have been above 48 per cent in 2020, would be above 36 per cent in 2021, and 23 per cent in 2022.

  • MMT proponents fail to acknowledge evidence that increased quantities of money in the economy will lead to inflationary pressures in the medium to long-term. This means that the surge in money growth in 2020 will be likely told in higher inflation later in 2021 and over 2022.

  • Central banks can either abandon monetary stability and low inflation by pursuing MMT, raising living costs and entrenching uncontrollable government spending. Or they can stick to stable economic growth and low inflation.

New IEA research, authored by the Director of the Institute of International Monetary Research Juan E. Castañeda, highlights shortcomings of Modern Monetary Theory (MMT).

In the last decade, MMT has gained traction as a set of policy proposals which can deliver economic prosperity to citizens without conventional concerns for government debt and budget constraints.

Advocates of MMT believe that the theory can deliver economic miracles, but this paper challenges such expectations. The research highlights that there is an unavoidable “correlation between excessive money growth and higher nominal income and inflation” over the medium to long term.

One issue is that MMT cannot square the inflationary circle. Although the pandemic may appear to provide the perfect opportunity for MMT to bail us out of economic turmoil, the research warns that it is “not the right solution if we want to keep a sustainable rate of growth in the economy with low inflation over the medium to the long term”.

While the response of central banks to the pandemic “fall a long way short of a fully-fledged adoption of MMT’s policies,” the adoption of MMT principles have become more common. This can be seen with the UK’s and US’s response to Covid-19.

As the US Federal Reserve has done in the US, in the UK the Bank of England has partially monetised government deficits through quantitative easing. This is where central banks buy government bonds or other assets from banks and other financial institutions with “newly created (purely electronic) money”. This process has resulted in an “extraordinary increase in the amount of money” in the economy.

The paper argues that had the UK adopted a ‘full MMT’ policy, and all government spending was monetised by the Bank of England, the annual rate of growth of money would have been above 48 per cent in 2020. Such levels would be “incompatible with stable economic growth and low inflation over the medium and long term”.

Dr. Juan E. Castañeda, Director of the Institute of International Monetary Research , Senior Lecturer (University of Buckingham) and author of “Modern Monetary Theory: Why it can’t provide sustained economic growth and low inflation,” said: 

“MMT provides a very attractive set of proposals for governments to support. True, in modern monetary systems, governments and central banks can create as much money as they wish, but this does not mean that there are no consequences from it. A central bank that systematically monetises the deficit of the government will perpetuate an economy with enlarged government deficits, unsustainable monetary growth and, in the end, higher inflation and macroeconomic instability. We have ample historical evidence and sound economic theory that support the relation between excessive monetary growth and inflation. 

“Since March 2020, the Bank of England has been monetising the government deficit to a large part, but it has paid no attention to the effects of this policy on the amount of money. Not surprisingly, the rate of growth of amount of money in the UK (broadly defined, by the monetary aggregate M4x) is the highest since M4 has been reported, currently growing at an annual rate of 15 per cent. This rate is clearly incompatible with the Bank of England’s remit of maintaining price stability over the medium term. The Bank should change course as soon as possible if it wants to rein in inflation and maintain its credibility.”