By FERNANDO NOGUEIRA DA COSTA*

Considerations on Modern Monetary Theory

Public debt has skyrocketed since the 2008 financial crisis, and especially during the covid-19 pandemic. According to the International Monetary Fund, the public debt-to-GDP ratio in advanced economies has increased from an average of around 70% in 2007 to 124% in 2020.

Fears that rising public debt would fuel future fiscal crises were dampened, in part, by the fact that the financial burden on government bonds has since been low. They were kept low by “quantitative easing” (QE) following the Great Depressions of 2008 and 2020.

The huge fiscal expenditures were justifiable to alleviate the suffering resulting from these episodes. But advocates of Modern Monetary Theory (MMT) take this abstract logic beyond local circumstances. They are different for the United States, the other advanced countries and the backward countries, submitted to the empire of the dollar.

TMM supporters claim that when the public debt is denominated in the country's own currency, there is no reason to fear a fiscal crisis, because a default cannot occur. Any withdrawal of fiscal stimulus given during crises, therefore, must be gradual.

Meanwhile, new issues of public debt securities can be used to fund investments in infrastructure, income support programs for the underprivileged and other items on progressive agendas. Post-Keynesian economists in mature countries highlight the condition that the inflation rate remains below the Central Bank's target of around 2%.

They do not analyze the reality of exporting countries of commodities. They are very dependent on the incentive of a depreciated national currency, but depending on the rate of exchange rate depreciation, there is a risk that the economy will suffer from “imported inflation”. Another reading, the orthodox one, is here the perception of the fiscal risk causing the exchange rate risk. As a result of this expectation, it is assumed that there is a flight of national capital and/or repatriation of foreign capital.

TMM supporters cite Japan as practical proof of their concepts. Although Japan's debt-to-GDP ratio (including both central and regional governments) is above 250%, compared to the current 160% in the United States, the yield on its ten-year government bond has remained around zero for the entire covid-19 pandemic, as well as its average inflation rate practically does not exceed the zero level 20 years ago. This information was given by Takatoshi Ito, former Japanese Deputy Minister of Finance, senior professor at the National Graduate Institute for Policy Studies in Tokyo (cf. Economic value, 30/12/21).

It is an out-of-the-ordinary or bizarre case. It's worth examining your insight. For other countries to emulate the case, they will have to issue public debt securities in national currency, almost all of which will be held in portfolios by their inhabitants, both directly and indirectly, through financial institutions and the Central Bank. This greatly differentiates Japan from the United States, whose Treasury bonds are held in reserves by investors around the world. But it doesn't differ so much from Brazil.

A correct understanding of TMM defenders is that the government does not need (and should not) fail to honor its public debt. If there are no buyers for it, the Central Bank may continue to place public debt securities in a free portfolio, even using them as backing for committed operations, as is done in Brazil.

In these operations, it wipes out any excessive liquidity in the interbank market. It would occur through injections of money due to the execution of budgetary expenditures by the National Treasury. This would not spur inflation during a deflationary Great Depression, as it did in the mid-2020s. TMM advocates would recommend these government bond issuances slow down when the inflation rate exceeds their target.

Cash transfers, such as social assistance (revamped for electoral reasons), and other programs benefit current generations, while the fiscal burden of future redemptions of public debt bonds will fall on future taxpayers – many of whom may not even be born yet . Even if outstanding bonds are rolled over indefinitely, interest payments for current consumption, financed by debt, will fall to future generations.

It is an extremely interesting case study. It is possible to make an analogy with an example of Ponzi Financial Posture: the one adopted by the Pay-As-You-Go Social Security System. In this, the current contributions of the economically active population pay the pensions of the inactive population.

This income transfer is viable even when demographic factors – increased life expectancy, decreased fertility rate, the resulting “aging” of the population –, conjuncture – rising unemployment rate –, and/or structural – higher degree of informality in the labor market –, cause growing deficits. This is where the social security crisis breaks out.

The validity of the MMR depends in part on projected real (inflation-adjusted) per capita growth. If the population is growing and future generations are wealthier than current ones, the “burden” of current bond issues will, in fact, be relatively small. In this sense, issuance of public debt securities to finance consumption, whether by employees or the needy, function as retirement systems based on the Simple Sharing Regime. As long as the economy is growing income (and consequently tax collection) faster in relation to interest charges, this regime will be one of continuous public debt rollover.

In that case, each generation can limit itself to pushing the onus on the next generation, ad infinitum. This until the aforementioned demographic, conjunctural and structural factors occur.

Like a pyramid scheme, fraudulent on earnings, this works only as long as the base, ie new entries, keeps expanding to support the exits. The Ponzi scheme involves promising abnormally high yields to be paid to investors at the expense of money paid by recruited investors afterwards rather than the revenue generated by any real business.

In a country with a growing EAP (Economically Active Population), the government may be able to continue to increase its public debt, as well as maintain its Social Security system based on the Simple Distribution Regime, for several decades to come. But in a country with a falling working-age population and stagnant per capita income, this scheme will soon collapse. It will be the case of Japan disclosed by Ito.

Japanese voters and politicians cannot continue to treat the money raised through new and rolled-over bond issues as an eternal godsend. If the electorate wants income redistribution, it has to accept the transfer should come from today's rich (many of whom are elderly) – not from future generations. If the Social Security System became too generous, due to optimistic projections, a reform of certain benefits should be promoted.

If fiscal stimulus is needed, spending should more sensibly be directed towards measures to support future growth, such as fostering investment in human capital and technological innovation. In this case, an analogy should be made with the two types of Capitalization Plans in Complementary Private Pension.

Defined Benefit Plans are characterized by setting the value of the benefits to be paid, leaving contributions – both by the employer and the employee – as a variable factor: the financial position of the company sponsoring the defined benefit plan is speculative. A government should not adopt this speculative stance.

On the contrary, the reference should be the Defined Contribution Plans. They are characterized by the fixing of the value of contributions, with the value of future benefits being variable. The economic perspective will depend on the capitalization of the contributions (or, in this case, on the good productive use of the public debt): the financial posture of the sponsoring company of the defined contribution plan is defensive, as it is recommended to be that of prudent governments.

Finally, for a generalized endorsement of the MMT and its implications for economic policy, is a certain caution necessary when descending from its level of abstraction to the here-and-now, for example, center or periphery? Therefore, when the acute phase of the pandemic crisis passes and income growth resumes, new rulers would do well to gradually reduce the huge stock of public debt.

*Fernando Nogueira da Costa He is a full professor at the Institute of Economics at Unicamp. Author, among other books, of Public Debt and Social Debt: Poor on Budget, Rich on Taxes, available for free download at https://fernandonogueiracosta.files.wordpress.com/2022/01/fernando-nogueira-da-costa-divida-publica-e-divida-social.-janeiro-2022.pdf.