Financial management: recent catastrophes in monetary policy management
In a world where economic theories often clash and debate rages, one approach that has gained significant attention, particularly in political circles, is Modern Monetary Theory (MMT). This controversial theory, backed by US presidential candidate Bernie Sanders and Democratic Congresswoman Alexandria Ocasio-Cortez, has been met with a mix of admiration and skepticism.
However, a closer look at the historical experiences of Latin American countries offers a different perspective on MMT's claims. Four examples—Chile, Peru, Argentina, and Venezuela—have experienced economic disasters, with similar ideas-based strategies leading to hyperinflation, fiscal crises, and economic instability.
One of the key concerns revolves around the risks of inflation and fiscal mismanagement. Latin American countries have faced episodes of severe inflation and hyperinflation, such as in Venezuela, linked to uncontrolled money printing and deficit financing. MMT proponents often downplay these outcomes, claiming they can be managed through proper policy tools. However, these episodes challenge MMT’s premise that sovereign currency issuers can finance deficits without triggering inflation if resources are available.
Another issue is fiscal discipline and inflation control. The failure to control inflation, despite raising taxes or confiscatory measures, as seen in Japan post-war, shows practical limitations to MMT’s assertions about taxation being the primary tool to control inflation and money demand.
Critics argue that MMT underestimates the economic consequences of persistent deficits and oversimplifies the fiscal-monetary relationship. Experiences in Latin America reflect that external pressures, debt accumulation, and capital flight constrain governments’ ability to sustain large deficits without economic instability.
The fiscal systems in Latin America often lack the redistributive and taxation capacity necessary for the proactive policies MMT endorses. Inequality and weak tax enforcement limit the effectiveness of fiscal policy, challenging MMT’s reliance on fiscal levers for macroeconomic management.
Moreover, the potential for moral hazard and governance problems arises when governments excessively exercise monetary and fiscal powers, as MMT might encourage. Experiences with interventionist policies in some Latin American countries, seen by critics as partly inspired by anti-liberal economic thinking, illustrate these risks.
Currently, Venezuela is a stark example of the pitfalls of MMT. The country has a deficit of 32 percent of GDP, with the money supply estimated to be growing annually by more than 1000 percent. In Peru, money supply growth was 7000 percent in 1989, with the budget deficit exceeding 10 percent of GDP. In Chile, the money supply increased by 360 percent in 1973, contributing to a budget deficit of 24 percent of GDP.
In Argentina, the deficit was 6 percent of GDP in 2015, with annual money creation exceeding 40 percent. In each case, the collapse of demand for national currency exacerbated the effects of money supply growth on inflation, creating a vicious cycle.
Evaluating MMT objectively is challenging due to a lack of a unified, detailed description of the model and few hints about how it would work in practice. MMT supporters often ignore the decrease in demand for local currency as a weakness of their theory, making its implementation extremely risky for any country.
In conclusion, the experiences of Latin American countries serve as a clear warning against fiscal expansions financed by the printing press, as they have led to an uncontrollable loss of economic stability. These historical examples form the core of critical challenges to MMT, highlighting the risks of inflation, ineffective fiscal control, and structural constraints outside the model’s assumptions. As the debate around MMT continues, it is crucial to consider these empirical examples to make informed decisions about economic policy.
- The example of Venezuela, with a deficit of 32% of GDP and an annual money supply growth exceeding 1000%, demonstrates the risks of uncontrolled inflation and economic instability that can occur when Modern Monetary Theory (MMT) is implemented.
- In the case of Argentina, where the annual money creation exceeded 40% in 2015, the collapse of demand for the national currency exacerbated the effects of money supply growth on inflation, creating a vicious cycle, which serves as an example of the ineffective control of inflation that can result from MMT's fiscal expansion policies.
