A set of radical ideas often supported by left-wing academics and politicians, Modern Monetary Theory (MMT) has risen in popularity in recent years, especially in the US, where some politicians view it as a way to drive funding for public services. 
With increasing numbers of market commentators and economists talking about MMT, Miton’s Anthony Rayner has explained what it means for investors.
Rayner (pictured), manager of Miton’s multi asset fund range, said that one of the overriding tenets of MMT is that a sovereign nation can’t default if it is issuing debt in its own currency and has a floating exchange rate.
He said: “More specifically, it suggests expansionary fiscal policy can be financed by monetary policy, providing more options to achieve full employment.”
In other words, this unconventional economic theory holds that governments can’t run out of money; they can’t face insolvency or have unpaid bills they can’t afford to pay. They never have to worry about the cash they need to spend; they can always print more money.
The theory has come into growing acceptance following the global financial crisis and the belief that current policy frameworks are failing, according to Rayner.
It has become increasingly discussed in the post-crisis, low-rate environment because MMT proponents believe that government spending should not be constrained by budgets but by the impact on inflation, which also remains low.
In addition, believers in MMT argue that any inflation above acceptable levels can be managed by higher taxation.
“Interest rates remain close to zero, growth is stalling in a number of major economies, inflationary pressures are far from evident globally and many are talking about the next round of QE [quantitative easing],” said the Miton multi-asset manager.
On that latter point, Rayner argues, a leap to MMT, or something like it, is much less of a leap as policy makers have already made the philosophical jump to QE.
“The sensitivity to higher levels of government debt has fallen over recent years,” he noted.
Federal Reserve Banks Total Assets
Source: Federal Reserve
Indeed, developed market governments have become more used to large levels of debt.
As the above chart shows, the US Federal Reserve massively expanded its balance sheet by embarking on an asset purchase programme following the financial aimed at shoring up the financial system and helping lift the country out of recession, only recently beginning to shrink the balance sheet.
In the post-crisis era, more governments are running higher levels of debt as a percentage of GDP compared to the pre-crisis era, said Miton’s Rayner, but without the usual side-effects such as sovereign bond and currency sell-offs, and debt restructuring programmes. The US, UK and Japan are notable examples.
General government gross debt (per cent of GDP)
Source: International Monetary Fund
Rayner said that ‘bond vigilantes’ have largely vacated their role of applying market discipline to government debt levels.
“There’s good reason for this: central banks have capped rates along the curve and thereby helped to limit the cost of debt,” he explained.
“In short, there’s less concern around debt sustainability, as material debt is more widespread, not isolated to a small number of ‘basket cases’, and central banks have their backs.”
But economics does not operate in a vacuum, the fund manager said, noting that politics and society are also important contributors to MMT’s rising popularity.
“Populism and inequality are both applying pressure for new solutions, questioning the effectiveness of the widespread austerity programmes which have seen inequality broadly stagnate and government debt as a percentage of GDP rise in many cases,” he said.
As an example, he cites the US where MMT has received renewed interest and has been put forward as a way to finance the Democratic Party’s proposed ‘Green New Deal’.
“The ‘Green New Deal’ is a radical stimulus proposal designed to address climate change and inequality, and has added to interest in MMT, as it’s been put forward as a way to fund it,” said Rayner.
Rayner cautions, however, that MMT could lead to currency devaluation as a result of printing money, increase the prospects of moral hazard, and reduce the independence of central banks.
MMT is also less relevant to economies that are close to full employment (such as the US) than to those that are not (such as the eurozone).
Unemployment rate and forecast (per cent)
Source: International Monetary Fund
Importantly though, he said, MMT doesn’t need to be embraced in its entirety to argue, for example, for increased public investment in infrastructure.
“Indeed, how the fiscal spend is generated is important but so is the investment target,” Rayner explained.
“For example, productive infrastructure versus ‘roads to nowhere’, or rather, making sure there are decent multiplier effects across the economy.”
MMT can be seen as a natural progression to QE, Rayner added, but the big obstacle there is political particularly around a dominant post-crisis narrative of austerity. There is also preference for small governments among policy-makers, which will also need to be overcome.
As such, Rayner said while the theory has taken hold in political and economic circles it may take some kind of shock for it to take centre stage.
“We don’t believe that inequality and populism are going away anytime soon but we think it would take something like a recession, or a systemic threat to the financial system, to drive these types of policies up the political agenda,” he concluded.