A previous version of this piece originally appeared in the Australian Financial Review[1] on March 13, 2019.
There is currently a popular debate on how to stimulate economies that are stuck with low productivity, low real interest rates, and a large amount of public debt. Proponents of an old idea in new clothes – modern monetary theory (MMT) – argue that central banks can solve these problems by buying large amounts of government debt and increasing the money supply. Advocates argue that the stimulus to demand would cause firms to unleash investment and produce a long sustainable economic expansion. This can only be described as a classic free lunch.
Free lunches have a long tradition in policy debates. They are politically popular and have recurred many times in the twentieth century and before. The experience with all economies that have swallowed the particular free lunch proposed by MMT enthusiasts is that it is very costly, and it can take a long time before unsustainable pressures eventually cause a disastrous outcome. The evidence on approaches like those proposed by advocates of MMT is that it always results in hyperinflation, massive social and economic destruction, and a crisis, followed by the imposition of more conventional economic policies. All existing experience– Venezuela today; Zimbabwe in 2008; Yugoslavia in 1994; Hungary in 1946; Greece in 1944; Wiemar Germany in 1923 — demonstrates the large costs.
Is it possible that traditional economics has missed something? Is it possible that this time MMT will perform differently?
When a government spends more than the revenue it generates, it usually finances its budget deficits by issuing government debt. Debt is a promise to repay lenders at some time in the future, for example...