Debt, deficits, and Modern Monetary Theory—there is a connection

There is no doubt that there is a connection between debt, deficit and modern monetary theory. And it is necessary to emphasize that the modern monetary theory says that the deficits are not so terrifying.

This being so, it is already well known that both the increase in deficits and the increase in debt are a frequent cause of dismay for markets and investors. In fact, historically each of them has often been charged with politics, with the main US parties labeled as free spenders (democrats) or deficit hawks (Republicans).

Even so, the approval of the Tax and Employment Cuts Act of 2017 and its important impetus to future deficits have erased the lines and may have made the previous labels irrelevant. In this way, it is necessary to bring up the fact that, in the 1930s, John Maynard Keynes affirmed that it was a radical idea at the moment when governments should borrow and spend to get the economy out of a deep recession. Seven decades later, politicians had accepted deficit spending unconditionally

New theory

It should be noted that currently, a “new” concept, the modern monetary theory (MMT), suggests that this may be truer than fiction. As proponents of MMT suggest that current deficits may be too small and that a day of “inevitable” future computation is not necessarily an inevitable conclusion.

It is important to mention that traditional economic orthodoxy is that high deficits translate into higher public debt issuance, which leads to higher interest rates that eventually suppress economic growth. Even so, it has clearly been observed during the record expansion of the US economy, interest rates have remained subdued even in the midst of greater debt issuance by the United States government.

Likewise, it is considered that MMT puts the government at the forefront and the center in the implementation of policies, entrusting it with sound and disciplined fiscal measures. Therefore, fiscal policy emanates from Congress and, due to this, it would be expected to act as a regulator, judging whether a new potential expenditure runs the risk of accelerating inflation and, if so, avoiding doing so. Consequently, it is understood that this discipline should, according to the theory, allow EE.UU Essentially self-financing future deficits, although for this it will be important that the US dollar maintains its reserve currency status.

Read more.

Source: Craig Bishop | RBC Global Asset Management