Stephanie Kelton’s “The Deficit Myth”, a more accessible manual to modern monetary theory (MMT), has brought the controversial school of thinking back into the spotlight. Though the subject of some fierce criticism, the underlying message is fairly simple: governments in control of their currency can finance as much spending as they want, and the only constraint is inflation. Given not only current but also historic unemployment and low inflation in the US and elsewhere, governments should therefore run much larger deficits with the goal of full employment. Kelton focuses chiefly on the US and discusses emerging market economies only briefly, but nonetheless does suggest EM economies could benefit from the policy prescriptions offered.
Unfortunately this seems like wishful thinking, particularly when the EM economy Kelton cites experimenting with MMT style policies – Argentina – has had well documented economic problems. However, some EM economies have evolved rapidly in terms of their monetary frameworks, and there may be some in a position to consider MMT in the not too distant future.
Kelton herself highlights the reason why MMT is a challenge for EM. The core proposition, that government deficits do not matter, only applies to so-called monetary sovereigns. That is, only governments with complete control over their currency do not need to worry about how much of it they need for their budgets. As soon as you tie your currency to something you do not control – whether that is gold or another currency – you face the well known budget constraint. Given the prevalence of currency pegs, both hard and soft, in EM, this rules out most of the universe immediately. Printing money in these cases threatens to break the peg with disastrous consequences for economic and financial stability. Going further, even without an apparent peg, any economy heavily reliant on foreign currency is also constrained; the domestic government can not provide the currency needed for the economy to function. In EM, this is typically the dollar, a currency whose dominance far outstrips the weight of the US in global trade.
Emerging markets have, however, come a long way since the crises of the late 90s and early 00s. While dollar debt is still widespread, governments have increasingly weaned themselves off the previously addictive substance. This is particularly the case in EM Asia, whose governments might then be able to consider running larger deficits at a time when inflation and growth are both subdued. Unfortunately, there are still some hurdles to be removed.
In many cases, even though sovereigns have cut back on dollar borrowing, local corporates have stepped into their shoes. Overall economic exposure to the dollar therefore remains high and so a large expansion of the monetary base could have adverse consequences beyond the inflationary effects normally expected. It is highly probable that the local currency would depreciate in proportion, increasing debt burdens for firms borrowing in dollars. Indeed, it is this fear that means many economies in EM maintain a so-called dirty float; intervening to prevent excessive currency volatility particularly against the dollar. This is particularly evident in China, despite that country’s extremely low share of foreign debt (around 10% of GDP). This effectively hamstrings fiscal policy; any attempt to follow MMT recommendations for monetary sovereigns would prove disastrous.
Hope is not permanently lost, however. While EM corporates have in many cases stepped into their sovereigns’ old shoes, the hope is that with a deeper and more liquid pool of risk free local currency assets, corporates will in time be able to follow their governments and reduce their reliance on dollar borrowings. This may not happen tomorrow, but in the late 90s there was undoubtedly a great deal of pessimism about the ability of EM sovereigns to boost their resilience too.
Meanwhile, EM would benefit from the practice of MMT elsewhere in the world, but particularly in the US. Not only would it boost US demand, but it would also act to increase the global supply of dollars and reduce funding and other costs for EM economies dependent on the dollar for trade and finance. EM investors then should cheer the adoption of MMT in DM, even as they fear it in their own markets.