Half-baked MMT: ‘Square the circle’ policy

There is no single individual who coined the term or theory, Modern Monetary Theory (MMT), which emerged and evolved over time through contributions from various economists since late 1990s. MMT has emerged as a distinctive approach to economic understanding, challenging traditional views on fiscal policy, government debt, and the role of money. Developed as a response to the limitations of classical economic theories, MMT proposes a different set of rules for sovereign governments issuing their own currency. This analysis examines the fundamental principles of MMT and conducts a comparative analysis with classical economic theories such as monetarism, Keynesianism, and neoclassical economics. Additionally, it scrutinizes how the partial and imperfect implementation of MMT principles contributed to Sri Lanka’s economic challenges, ultimately leading to bankruptcy.

Key Principles of MMT

MMT disrupts conventional economic wisdom by asserting that sovereign governments with their own currency face different constraints than households or businesses. Notable principles of MMT include:

Currency Issuer vs. Currency User: The essential claim of MMT is sovereign currency issuing governments do not need taxes or bonds to finance government spending and are financially unconstrained. MMT argues that those governments can create money without the same revenue constraints as households or businesses. This challenges traditional views on financial restrictions in funding government expenditures.

Functional Finance: MMT emphasizes focusing on the functional outcomes of fiscal policy rather than blindly pursuing budgetary balance. Fiscal policy refers to the use of government spending and taxation to influence the economy. It is one of the two main tools used by governments, alongside monetary policy, to achieve macroeconomic objectives such as economic growth, employment, and price stability. Fiscal policy involves decisions made by the government regarding its revenue collection (taxes) and expenditures. It advocates using fiscal policy to achieve full employment and price stability, regardless of the level of government debt.

Job Guarantee: MMT introduces the concept of a job guarantee programme to attain full employment. By creating a buffer stock of jobs, the government can stabilize the economy, adjusting the programme size in response to changes in private sector employment.

Comparison with Classical Economic Theories

Monetarism: Monetarism, associated with economists like Milton Friedman, places significance on the money supply’s role in determining inflation and economic stability and that fiscal policy plays a more pivotal role in shaping economic outcomes. MMT challenges this by asserting that money supply is endogenous, meaning it is determined by the decisions of the government and the banking system, rather than being constrained by fixed factors like the money supply or a gold standard,

Keynesianism

Keynesian economics, attributed to the influential economist John Maynard Keynes, proposes active government involvement in the economy through fiscal policy, aiming to regulate demand and stabilize economic conditions. This approach suggests that during economic downturns, the government should increase spending or reduce taxes to stimulate demand, and during periods of inflation or economic boom, it should implement measures to curb excessive demand.

In comparison, Modern Monetary Theory (MMT) aligns with Keynesian principles but extends them further. Both theories acknowledge the role of government intervention, especially through fiscal policy, to influence economic conditions. However, MMT places greater emphasis on the unique capacity of a government that issues its own currency. According to MMT, such a government has the ability to create money, making it distinct from other economic entities.

In essence, while Keynesian economics emphasizes discretionary fiscal policies to manage economic cycles, MMT introduces the idea that a government with its currency has more flexibility and control over its fiscal policies. MMT challenges the traditional view that governments must rely on tax revenues or borrowing to fund expenditures, asserting that a sovereign currency-issuing government can essentially create money as needed.

Neoclassical Economics: Rooted in the ideas of classical economists like Adam Smith, neoclassical economics focuses on market-driven mechanisms and resource allocation efficiency. MMT challenges this view by asserting that markets alone may not ensure full employment, advocating for necessary government intervention to achieve macroeconomic stability. (See diagram)

The case of Sri Lanka

According to the Central Bank of Sri Lanka (CBSL), Rs. 130 billion was printed in October 2021 alone and Rs. 2.8 trillion from December 2019 to October 2021. The CBSL, under certain Governors such as Ajith Nivard Cabraal and Prof. W. D. Lakshman, contended that money printing did not lead to inflation. However, concerns have been raised about the impact on the Sri Lankan economy. MMT advocates for sovereign currency-issuing governments to adopt flexible exchange rates, allowing for greater autonomy in monetary policy. The CBSL’s decision to opt for a fixed exchange rate instead of a flexible one deviates from these recommended principles, giving rise to significant apprehensions. Under a fixed exchange rate, DBSL faced limitations in conducting independent monetary policy, potentially leading to vulnerabilities, balance of payments issues, and coordination challenges between fiscal and monetary authorities. The decision between fixed and flexible exchange rates involves trade-offs, and in the specific context of Sri Lanka, careful consideration of these implications is necessary. CBSL management has opted for a fixed exchange rate, citing concerns about an unrealistic policy aiming to prevent rupee depreciation. Former CBSL Governor Prof. W.D. Lakshman’s directive to keep the USD selling rate below Rs. 203 led to reluctance among exporters and a drop in worker remittances.

According to many economists (for example, Professor Sirimal Abeyratne, Professor W. A. Wijewardane), the country’s adoption of this half-baked MMT in 2020 was a major factor that contributed to an increase in money supply and inflation. MMT challenges the notion that printing money inherently causes inflation, asserting that governments can create as much money as needed without adverse effects, especially when an economy is not at full capacity. Some argue that Sri Lanka is the first country in the world for citing MMT officially as a justification for money printing.

Many economists have expressed concerns about Sri Lanka exceeding its money-printing limits, leading to inflation and potential economic challenges. The study by CBSL Assistant Governor Swarna Gunaratne has stresse that money printing should align with the value of overall transactions in the economy to avoid inflationary pressures.

As reported by Bloomberg, in typical populist regimes, those who criticized the adoption of unconventional theories as official policy were often dismissed as foreign agents, elitists, or pessimists. Any advice from sources outside the inner circle of the Rajapaksas was disregarded, even from mainstream economists and the International Monetary Fund. Unfortunately, this resistance to conventional economic counsel led Sri Lanka down a perilous path, illustrating the consequences when crank theories become official policy. Within two years, the country found itself on the verge of default and economic ruin. The promotion of such ideas is typically associated with fringe perspectives.

In conclusion, the case of Sri Lanka highlights the intricate dynamics surrounding MMT. Supporters argue for the benefits of controlled money printing under specific conditions, while critics in Sri Lanka emphasize the necessity of prudent monetary management to avert inflationary pressures and economic destabilization. The country finds itself in a policy dilemma, navigating between the imperative for economic growth and the inherent risks associated with excessive money printing. This situation underscores the complex interplay between economic theories, policy decisions, and their real-world repercussions. The adherence to a fixed exchange rate, controversial monetary policies, and resistance to mainstream advice have collectively contributed to economic challenges in Sri Lanka, prompting a critical examination of the practical application of MMT in specific contexts.

(The writer, a senior Chartered Accountant and professional banker, is Professor at SLIIT University, Malabe. He is also the author of the “Doing Social Research and Publishing Results”, a Springer publication (Singapore), and “Samaja Gaveshakaya (in Sinhala). The views and opinions expressed in this article are solely those of the author and do not necessarily reflect the official policy or position of the institution he works for. He can be contacted at saliya.a@slit.lk and www.researcher.com)