Exceptional economic and financial crises often demand exceptional remedies. It was in this spirit that many governments, fearing another Great Depression, intervened heavily in their economies during the 2007-2009 financial crisis. While the adopted fiscal actions, involving both government expenditures and tax cuts, were quite substantial, they were nevertheless easily eclipsed by the massive levels of central bank monetary interventions. In the United States, for example, the level of the fiscal stimulus used was about $940 billion, while the amount of the new money injected into the economy by the Federal Reserve System (the Fed) reached almost $3,200 billion. (In contrast, the Fed had printed a total of only $800 billion in the preceding 100 years.) One major reason for the dominant role played by central banks during the crisis was the reluctance of many legislatures to endorse the needed expansionary fiscal measures out of the fear of enlarging their national debts. In contrast, many monetary authorities, enjoying some degree of political independence, were in a better position to act faster and more decisively in meeting the sharply rising liquidity needs of their economies. Unfortunately, however, as it has been usually the case, the use of monetary policy alone once again proved lacking in dealing with the crisis. This was because, given the extremely high risk levels during the crisis, much of the money that the central banks pumped into their economies was hoarded as idle balances, rather than invested in new capital goods. Thus, a combination of the relatively modest fiscal actions and the less than effective monetary policies tended to produce, not surprisingly, a global economic recovery that was disappointingly slow. Adding to this problem, many governments also began to prematurely withdraw or even reverse their expansionary policies before the global economy had had sufficient time to fully recover. As a result, it took almost a decade before the unemployment rates in some industrial countries returned to their pre-crisis levels.
One important side effect of the slow economic recovery from the 2007-2009 crisis has been the rise of the so-called modern monetary theory (MMT), a school of thought challenging the traditional reliance of monetary policy on the so-called quantitative easing and instead offering a new and more effective approach to the conduct of monetary policy. The following pages describe the MMT and examine its particular implications for the current coronavirus crisis.
There is no question that even the most severe economic downturns can be remedied by aggressive fiscal actions, especially in the form of government expenditures. For example, the Great Depression of the 1930s was largely resolved through the massive public expenditures associated with the Second World War. However, as stated earlier, most fiscal actions are subject to a long and arduous process of legislative approval, a shortcoming that adds to the appeal of monetary policy as the easiest way to address promptly any severe economic threat. While useful, however, monetary policy itself suffers from its traditional reliance on quantitative easing, in which central banks purchase financial assets, such as government bonds, and pay for them by printing their own money. The increased central bank money can in turn lower interest rates and produce higher levels of economic activity. At the same time, while quantitative easing can be effective in dealing with moderate recessions, it loses much of its potency during the times of severe economic crises. During these times, as indicated before, many investors may simply decide to hoard cash, rather than endanger their financial health by investing in various financial and physical assets. For example, during the 2007-2009 financial crisis, almost 80 percent of the cash that was pumped into the US economy by the Fed was hoarded by commercial banks, as these banks were fearful to lend, and, of course, many businesses were also reluctant to borrow, given their gloomy business prospects. Under these conditions, pumping more money into the economy to stimulate private sector spending can only result in a so-called liquidity trap, a situation characterized by plenty of cheap money, but little appetite for private borrowing and spending.
A better approach to boost aggregate spending in the economy during the tough economic times, according to the MMT, is for governments themselves to borrow directly from their central banks and invest the proceeds in a host of productive projects, such as basic research, green technology, bullet trains, education, and healthcare. In addition, governments are also encouraged to distribute some of their central bank borrowings as free cash to those who have been especially hit hard by the adverse effects of the economic crises. Thus, instead of quantitative easing, which can be slow-acting and possibly even harmful by generating asset bubbles in the economy, the MMT calls for governments to essentially use helicopters to drop money like manna from heaven for the benefit of both their businesses and consumers. Indeed, the proponents of the MMT assert that the use of the helicopter money during the 2007-2009 crisis would have considerably quickened the pace of the global economic recovery. In a similar vein, they also believe that, while still waiting for effective vaccines and treatments for the ongoing coronavirus pandemic, the extent of its severe damage to the economy can be minimized by the use of the same MMT approach. Thus, according to the MMT, instead of having fiscal and monetary policies acting independently from one another, we should coordinate them into a unified and more powerful economic tool of crisis management.
Interestingly, while the MMT was originally only supported by the left, the current crisis has provided increasing support for it also from the right, as evidenced by recent pronouncements of such traditionally conservative entities as the European Central Bank, the Fed, the Goldman Sachs, and the International Monetary Fund. Indeed, there are already signs that the MMT is gaining increasing acceptance among policymakers of all political persuasions. For example, most of the recent $2,200 billion of the US coronavirus stimulus package, which included substantial handouts to the struggling businesses and consumers, was financed by the printing presses at the Fed. In addition, there seems to be another major US bipartisan effort to do even more of the same, given that millions of Americans are still losing their jobs, their businesses, and their residences, while desperately trying to stay above the poverty line. Needless to add, once the crisis is over, the MMT recommends raising taxes and adopting tighter monetary policies to stem any future inflationary pressures in the economy.
Given the general impotency of the traditional quantitative easing in dealing with severe economic crises, many economists, both from the left and the right, are now advocating the use of the more effective MMT approach to deal with the ongoing coronavirus crisis. According to this approach, central banks should aggressively and cheaply underwrite the expenditures of their governments on both infrastructural projects and on direct cash payments to those especially harmed by the crisis. Given the low costs of borrowing from the central banks, the MMT also asserts, quite correctly, that many such government projects will be able to eventually pay for themselves. In addition, and in the light of the present dire prospects for the global economy, the MMT also rejects as baseless the perennial warnings of the austerity-minded economists who consider any use of such helicopter money, even during major economic crises, to be necessarily inflationary.
By: Hassan M. Shirvani
Professor, Economics & Finance