The real reason to worry about MMT is not theory but practice


Thus, all governments (including the Hawke-Keating government) decided to fund their deficits solely by selling government bonds to the public. Ironically, this meant that the banking system (not an individual bank, but the system as a whole) could continue to create money, but the government – despite being the issuer and funder of the currency – could not.

The monetarist dogma that creating money inevitably leads to inflation has been proven wrong. It is inflationary only if it causes the demand for “real resources” – land, labor and physical capital – used to produce goods and services to exceed the supply of real resources. Until you reach this point, the creation of more money – whether by the banking system or the government – should give you stronger demand and more jobs without causing problems.

So the real reason to worry about MMT is not theory, but practice. If you give a bunch of vote-buying politicians the right to spend as much as they want until a certain pointhow could you be sure that they would stop and start borrowing again when they reached that point?

This is what Lowe is really talking about, although he doesn’t want to say it.

Since last year, it has had no choice but to join the other larger economies in resorting to “quantitative easing” (QE) – the central bank buying second-hand government bonds, in order to to reduce the “yields” (interest rates) on these bonds, but paying them simply by crediting the bank accounts of the bond sellers.

In particular, since March last year, the Reserve guaranteed that it would buy enough bonds to prevent the yield on three-year Australian government bonds from rising above 0.25% (later reduced to 0.1 %). In practice, as the market believed the Reserve would honor its promise, it did not have to buy as many bonds as it did last week.


Then, last November, the Reserve went further with quantitative easing, announcing that it would buy $100 billion worth of used federal and state bonds with maturities of five to 10 years in order to force their also give in. The Reserve estimates that these purchases lowered yields by about 0.3 percentage points.

Last month it decided to buy another $100 billion. Questioned by Labor’s Dr Andrew Leigh before the House Committee, Lowe and his deputy, Dr Guy Debelle, revealed that $80 billion of the first $100 billion had gone to federal government bonds (as opposed to bonds of State), which represented about 10% of the entire outstanding stock of federal government bonds.

The additional $100 billion would bring the Reserve’s share of the federal government’s total debt to 20%. If there was yet another $100 billion purchase after the second, that would bring its stake to 30%. With the Reserve buying used bonds at a steady rate of $5 billion a week, it was buying more than the New bonds the government was issuing to finance its huge budget deficit, Debelle revealed.

In his opening statement to the committee, Lowe insisted that “the RBA does not and will not fund governments directly. The bonds we own will have to be repaid in the same way as if they belonged to others.

“We reduce the cost of funding for governments – as we do for all borrowers – but we don’t provide direct funding. There remains a strong separation between monetary and budgetary [budgetary] politics,” he said.

That last sentence is key to why Lowe draws such fine distinctions. Fiscal policy is controlled by politicians, while monetary policy is controlled by the Reserve, which is independent of the elected government.

The Reserve is buying all these second-hand bonds of its own volition, because it thinks QE is part of monetary policy’s best contribution to getting people back to work. It is not acting under any government directive to directly finance its deficit. Thus, the problem of pollies continuing to spend beyond the point where it becomes inflationary does not arise.

All true. But Lowe can’t suspend the truth that money is “fungible” – all dollars are interchangeable. Financing the deficit indirectly rather than directly may be important from a good governance perspective, but from an economic impact perspective, it is the same thing.

Let us return to the views of Professor Garnaut: “Fiscal deficits should be mainly financed directly or indirectly by the Reserve Bank, at least until full employment is in sight.

Ross Gittins is the economics editor of the Herald.


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