Can Modern Monetary Theory lead to full employment?

The world is more levered today that it has ever been in the past and almost half of the increase in net debt over the past decade has come from emerging market economies. With rising government debt, fiscal policy has become increasingly constrained globally. In some countries, austerity has meant higher unemployment.

Many mainstream economists have even warned about the coming collapse of the world as we know it, especially should the next recession hit, and given the ‘limited fiscal space’, no fiscal stimulus would be possible this time. In the United States, rising fiscal deficits and aggregate debt are viewed as a recipe for eventual disaster for the economy. This is of course not a new debate. For decades now, we have been hearing about the same old story : the US will go broke if it does not cut spending or raise taxes to fund its expenditure, but the US still lives on. At the same time, central bank policies, which have stabilized the financial system from complete collapse during the great financial crisis, have been blamed for creating distortions and even contributing to rising wealth inequality. Many countries all around the world are facing a demographic problem and are wrestling with the challenges that come with the fourth industrial revolution.

A limited fiscal space in theory at least complicates matters. In the case of Mauritius, the likes of the International Monetary Fund and our own economists have advised various governments to impose a target debt-to-GDP ratio and constrain fiscal spending. There has also been a lot of criticism about the government becoming an ever larger employer, of engaging in populist measures which, it is argued, can only lead to a more dangerous situation. Given a low tax regime and a 50% debt to GDP target, fiscal policy in Mauritius is highly constrained. We may actually never get to the target given our near 70% debt to GDP (IMF adjustments), but the mere fact of needing to show a fiscal deficit that is below 4% of GDP in the short term and 3% of GDP in the medium term does lead to constraints, especially as grant money dries up in the coming years. If the world economy continues to struggle, or if there is a global recession, then Mauritius’ fiscal deficit will be even higher given lower growth. It is clear that conventional thinking and policies have their limits. Various local dispensations in fact have made use or have wanted to make use of grants from abroad to finance capital expenditure given the reluctance to increase taxes. The private sector in turn suffers from low corporate savings and is not very free cash flow generative, and if one adjusts for investments within the real estate sector, there is not much in terms of productive private investment occurring in Mauritius.

The labour force has important skills mismatches and is underemployed. In the coming decade, the ageing of the population will not only put pressure on the savings rate but on labour input growth as well. Few may have noticed it, but the current level of inflation in Mauritius is very low with both year on-year and core inflation rates being increasingly indicative of not only external factors but of an economy that is growing below its mid-4% potential. If we put a mainstream economist hat on, there is not much the government can do about it. The purpose of this article then is twofold: firstly, it is to explain that while private debt is debt, locally denominated government debt is actually private savings and that a limited use of Modern Monetary Theory (MMT), when tailored, can actually allow Mauritius to grow at its potential without higher inflationary costs.

Sameer Sharma is a chartered alternative investment analyst and a certified financial risk manager.

Source : Conjoncture May-June 2019.

By Sameer Sharma
(1st part)