If after the great financial crisis of 2007-2009 the word “extraordinary” characterised monetary policy, the Covid-19 pandemic calls for a much stronger adjective: “unprecedented”.
As the world has never before been faced with an instance when virtually all economic activity stopped for a certain period of time, this is an appropriate word. However, in monetary policy really very little can be said to be truly “unprecedented”.
For example, take modern monetary theory (MMT) — a theory about how to have your (monetary) cake and eat it, which (simplistically) states that if a country can print its own currency, that country will never default on its debt because it can create as much currency as it wants to and use it to pay back the debt.
Major central banks, to a certain degree, have already begun versions of MMT.
The Bank of Japan was the first to start massive purchases of assets from the markets, more than two decades ago. Japan’s total debt is a massive 250% of gross domestic product currently, from under 75% in 1997 when it first started asset purchases by buying commercial paper issued by banks.
In 2008-2009, the Federal Reserve and the Bank of England started their own quantitative easing. In July 2012, the European Central Bank (ECB) saved the eurozone, with then President Mario Draghi famously stating that the central bank will do “whatever it takes” to preserve the euro.
US academic Stephanie Kelton’s book “The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy” couldn’t have been published at a better time.
Essentially, the book argues that if governments have a spending plan that would help the economy, they should go ahead and spend without worrying about increasing budget deficits. A country that prints its own currency can go ahead and cover its deficit.
Like all bold ideas put forward in times of crisis, this one is as scary as it is appealing.
Société Générale strategist Albert Edwards, renowned for his bearish but often correct analysis, gives an idea how scary. In a recent research article discussing the book, he says:
“The Kelton quote that I like best, in reference to ‘conventional’ policy thinking, is: ‘We have let our imaginations become far too limited, and it’s holding us back’. Rest assured there is no lack of imagination on these pages, but sometimes, like a wretched, shunned soothsayer from the Dark Ages, I wish I couldn’t see the things I see.”
And if the experiment we are in right now — in which central banks print money and governments spend it — is relatively novel for developed countries after the war, it was tested in the developing economies of Eastern Europe after the 1989 fall of communism, with dire consequences.
As centralised economies collapsed, governments ordered the central banks to print money so they could distribute it to people in the form of various benefits.
Another use for this printed money was as subsidies to state-owned companies, which were kept afloat even through they were loss-making for the sole reason that they provided jobs for millions of people, who would otherwise have had no source of income.
Some countries had it worse than others. Those who undertook the so-called “shock therapy” and closed down loss-making state-owned firms quicker were rewarded by a shorter crisis and more foreign investments.
Others, whose governments were afraid of upsetting voters, dragged their feet on reforms and had to deal with the rampant inflation brought on by this cycle of money printing and spending.
In some countries, inflation was running at more than 300% a year and things were so tough that at one point, for example, children had to choose between one banana and one orange for their weekly treat: prices had doubled and the parents could no longer afford to buy both.
If Albert Edwards wishes he couldn’t see the things he sees, many Eastern Europeans who grew up in those days wish they had not seen the things they saw.
Will policymakers in developed countries study what happened in the emerging economies of Eastern Europe in the 1990s, before fully embracing modern monetary theory? Judging by their record on previous occasions, I am not holding my breath.