Wednesday, September 25, 2019

Modern Money Theory (MMT) in the Tropics


Paper has been published as a PERI Working Paper.

From the abstract:

Functional finance is only one of the elements of Modern Money Theory (MMT). Chartal money, endogenous money and an Employer of Last Resort Program (ELR) or Job Guarantee (JG) are often the other elements. We are here interested fundamentally with the functional finance aspects which are central for any discussion of fiscal policy and have received more attention recently. We discuss both the limitations of functional finance for developing countries that have a sovereign currency, but are forced to borrow in foreign currency and that might face a balance of payments (BOP) constraint. We also analyze the limits of a country borrowing in its own currency, because there is no formal possibility of default when it can always print money or issue debt. We note that the balance of payments constraint might still be relevant and limit fiscal expansion. We note that flexible rates do not necessarily create more space for fiscal policy, and that should not be in general preferred to managed exchange rate regimes with capital controls. We suggest that MMT needs to be complemented with Structuralist ideas to provide a more coherent understanding of fiscal policy in developing countries.

Read full paper here.
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1 comment:

  1. Biagio BossoneOctober 13, 2019 at 4:39 AM

    Dear Matias,
    Many thanks for your contribution. I have read your full paper with Esteban Pérez Caldentey with great interest, and I am very much in agreement with most of what you say.
    I would only be critical about one point that you make and reiterate many times in the paper, and which is as well one of the core points of MMT: a government that spends its own floating and currency cannot be forced into default in that currency. This is legally true but economically is not.
    Even though debt contracts may be stipulated in nominal terms, creditors are interested in making sure that they recover the full “real” value of their lending. Repaying in a currency that depreciates, and whose rate of depreciation is not fully compensated, is not a default in legal terms but it is economically equivalent to it.
    Were it not so, there would always be a “free lunch” that governments could exploit by borrowing in a domestic currency that they can always print unlimitedly. Now, this does happen and has indeed happened many times in practice everywhere where government exploit domestic borrowers, especially small and uninformed savers, with limited capacity to invest their money, and active mainly if not exclusively in the domestic (captive) capital market. But when national economies are highly financially integrated and their debt liabilities trade in the international capital markets, international investors do become the “marginal investor” and, as such, they determine the price of those liabilities. The role of the “international marginal investor” as price maker of national liabilities is further reinforced where wealth is highly concentrated and higher shares of domestic savings are intermediated by institutional investors.
    In situations such as the one just described, the international marginal investor assesses the debt repayment capacity (in real resources) of the borrower (say, the government): that capacity would be the same whether the contracts are written in domestic or foreign currency. The fact that the government may print infinite amount of domestic currency, while it may not do the same with the foreign currencies, does not alter - ex ante - the (real) losses that the investor would expect from contracts expressed in different currencies, and the terms of the contracts would be written so that the investor would be indifferent between them, that is, in terms that protect the investor from the risk of default in all cases, whether the default consists of interruption in the debt service or whether it derives from repayment in a depreciating currency: the debtor is the same as well as its capacity to repay (in real terms).
    Would’t you agree?
    I make this point analytically in my recent http://www.economics-ejournal.org/economics/journalarticles/2019-33
    where I evaluate the implications of resource allocation decision being taken by the "international marginal investor" rather than the typical representative domestic household. Thanks for your attention.

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