Modern Monetary Theory and inflation

Friday, 2 July 2021 00:00 -     - {{hitsCtrl.values.hits}}

The Government on Monday printed an astonishing Rs. 208.5 billion soon after Rs. 23 billion last week, to fund the purchase of Treasury bills following a failed auction. This is not the first time this has happened this year. The latest move, for some, apparently signalled that the Government’s economic management is gradually veering towards a state of outright alarm.

The Government’s intention to pursue an economic policy based on Modern Monetary Theory (MMT) has been made abundantly clear in recent times. The main feature of MMT is printing money via the Central Bank to finance Government expenditure and budgets. However, critics, many of whom hold a classical view of economics, note that this has the potential to lead to uncontrolled inflation if done without restraint.

Proponents of MMT argue that a Government should be allowed to create as much new money as it needs so long as it does not lead to inflation. Inflation, according to MMT, can be mitigated by spending less and by the Government removing money from the economy through taxes.

Problems only begin to arise when a country is unable to produce enough goods and services to meet the added spending arising as a result of the increase in circulation of new money in the economy. 

This, incidentally, is what happened in Zimbabwe in the late 1990s, where a combination of Robert Mugabe’s regime printing ever more Zimbabwean dollars and a sudden decline in its agricultural sector – a result of moves by Mugabe to remove and reallocate farmland from white farmers to soldiers that had fought for him, but crucially were not very good at farming – led to astronomic levels of hyper-inflation.

In Sri Lanka, the present Government has used bank money in a big way to finance its expenditure. During 2020, it borrowed a record Rs. 1,753 billion from the banking sector. Of this, what it borrowed from the Central Bank amounted to Rs. 506 billion, another record in the post-independence period. 

During 2020, the total money printed had been Rs. 1,781 billion. The Government was responsible for 98% of that increase. This trend is now seemingly being repeated in 2021 because of the suppressed revenue base of the Government and its inability to borrow adequately from abroad. 

There is a concern however that the ease of printing increasingly more money will eventually lead to the Government relying on it more and more in terms of financing its budgets, as opposed to more financially prudent, but politically unpalatable methods, such as raising taxes.

The Government though could argue that utilising this newly printed currency to undertake infrastructure projects would in the long-run counter the effects of inflation, as a result of the potential economic development stemming from these projects increasing market supply through increased production.

This though is not by any means a safe strategy. As it stands, prices have not increased officially, but that is because of price controls put in place by the Government – though it must be pointed out that nowhere in the market are goods available at those controlled prices.

If, or most likely when, inflation sets in, defying the Government’s price controls, this is when the Government and the public will start to feel the real pinch of these policies. And by then it might be too late.