Don’t Try This At Home! Rabobank’s List Of Economies That Should Shun MMT
In the midst of a global recession, matched by localised economic contractions across a number of economies, the once-fringe theory of Modern Monetary Policy is becoming more mainstream.
Public debt is soaring and the idea that governments can print money indefinitely, constrained only by inflation, is seductive for administrations. MMT, however, can only work for a handful countries. Rabobank, in a July 20 report, said its analysis suggests that only eight economies have conditions that can allow them to consider MMT as a policy option.
“MMT is a medicine that will likely hurt more patients than it cures. Very few economies can hope to take it on a sustainable basis,” Rabobank’s Michael Every, Hugo Erken and Erik-Jan van Harn wrote in the report.
In determining the countries that can use MMT, Rabobank looks at three sets of conditions.
- First, countries that have currencies pegged to another country and don’t have their own sovereign currency are ruled out.
- The second set of triggers is the fiscal and current account deficits as a percentage of GDP over time.
- Third, Rabobank looked at whether countries have the policy discipline to turn off the fiscal taps if inflation is too high. To assess this, they looked at the World Bank’s measure of institutional quality, with the condition that the country must be above the median for this global measure.
In short, we ask: which economies consistently run a fiscal deficit and a current account surplus and are well-governed?Rabobank Report
According to Rabobank, only eight countries in the world met its ‘MMT criteria’. “Leaving aside the U.S., these countries need the rare combination of sovereign currency, simultaneous fiscal deficit and current account surplus, plus good governance,” the economists wrote.
The economies included in the ‘go-for-it’ category are those which consistently run a fiscal deficit and a current account surplus and are well-governed.
Rabobank explains that if a country runs a large fiscal deficit (-12% of GDP, for example), but runs huge household and business surpluses (for example, a private sector surplus of 14% of GDP in total), then internationally the country is a net lender not a borrower. “So it can keep control of both (low) interest rates—as long as it faces no inflation problems domestically—and the exchange rate.”
Strong governance and strong institutions, meanwhile, help in ensuring that timely steps are taken if adverse consequences of an MMT-like approach show up.
Among large economies, the U.S., China and Japan could consider MMT. The Eurozone could as well but has chosen not to, said the report. Among Asia, Malaysia and Thailand are contenders.
China, Japan, and the U.S. collectively constitute 38% of world GDP, all of the other listed economies are relatively small. Asia is well represented, Africa has only one candidate, as does Latin America, and Europe has none, albeit this is a self-imposed political choice in the former case. Overall, our analysis does not suggest that the world can rely on MMT, despite the current hype about it.Rabobank Report
Beyond the countries which have conditions amenable to an MMT experiment, Rabobank says there are a few countries that run twin surpluses. Could they handle MMT? “In some cases, a fiscal deficit might lead to a private sector deficit and so a current-account deficit: in others it might not. We take a conservative view and say they should not,” the economists said.
The ‘Don’t Even Try It’ Club
Then there are the countries that should not even think about MMT. India falls in this category.
These are countries that run both a fiscal and current-account deficit already. “Debt monetization from this position surely spells trouble,” Rabobank said. The report says that countries that run a fiscal surplus and a current account deficit are also in the vulnerable position.
This bucket encompasses many key emerging markets, such as India, South Africa, Indonesia, the Philippines, and Poland. Large economies like the U.K. and Australia are also put in the ‘don’t even try’ bucket...Rabobank Research
In the case of India, in particular, Rabobank cautions of worrying consequences should the government go down the direct debt monetisation route. While this may not have too many negative repercussions immediately because of the risk-off sentiment, it could be extremely damaging in the long run.
As a hypothetical example, Rabobank says that if India were to announce another 10% of GDP or $270 billion package (similar to the size of the first economic support package), but fund it by printing fresh money, inflation may surge and the currency may plummet.
“As a first side effect, our model simulation shows that inflation might spike to 12% on average in 2021,” the economists said. “As a second side effect, our simulation shows that the rupee will be crushed: the Indian rupee would depreciate by 16% against the U.S. dollar in 2021 compared to 2020 levels and almost 25% against 2019 levels.”