In the latest edition of BofA’s closely-watched global fund manager survey, more than 200 panelists who together control some $600 billion in AUM were presented with a list of prospective structural shifts for the post-COVID world.
If you follow the narrative, you could probably make the list yourself. It’s widely understood that the pandemic will give rise to a reinvigorated protectionist clamor, a push to on-shore supply chains, and epochal shifts in the way we think about monetary and fiscal policy.
Participants in the BofA survey were asked to choose which of the following were the most likely to play out:
- Supply chain reshoring (localization)
- Rise in protectionism
- Higher and new forms of taxes
- Debt exemptions for private and public sector (MMT)
- Green energy and sustainable infrastructure
- New era of stagflation
- Another decade of disinflation or even deflation
- Introduction of universal basic income
- Global growth based on global trade cooperation
Not surprisingly, very few respondents see the pandemic ushering in an era of increased cooperation aimed at solving common problems, which is supremely ironic given that’s what’s arguably necessary to prevent future calamities.
In any event, the breakdown of responses is as follows:
Virtually all of those issues have been discussed here at length over the course of the past two months, including dozens of articles on the inflation/deflation debate (latest here, here and here) and the myriad contentious issues around deficit financing, taxation and debt.
Note that 42% of respondents to the BofA FMS think higher taxation is coming, while nearly a quarter see some form of MMT as likely. I touched on both issues in the context of Gary Cohn’s interview with Fareed Zakaria on Sunday in “Congress Needs To Be Ready To Spend $3-5 Trillion ‘At Any Given Moment’ In Crises“.
One of the most crucial points to grasp is that central banks have been monetizing government debt for years, it’s just that the general public never had much interest in connecting the dots between QE, deficits, and the superfluous middlemen (primary dealers) who effectively act as a very thin veil between central bank asset purchases and direct deficit financing.
Thanks to the COVID crisis, the public’s interest is piqued. As I wrote Sunday, if Americans have any sense about them at all, they will start to question the mechanics of this arrangement. Specifically, they will ask why, if this charade is as laughably transparent as it clearly is, we need the primary dealers in the middle of things. Why not just have the Fed directly finance the deficit? Taking it one step further, if all we’re doing in that scenario is issuing debt and buying it from ourselves, why issue the debt in the first place?
Well, if you ask Morgan Stanley, the close coordination of monetary and fiscal policy won’t necessarily usher in an era of overt MMT. To wit, from the bank:
While monetary and fiscal policies are now more coordinated, we don’t think that we have entered the realm of Modern Monetary Theory, as some have suggested. While central bank independence faces risks (more de facto than by legislative changes), particularly in EMs, we think that DM central banks are unlikely to relinquish their independence and commitment to inflation targets. They may not act at the first sign of inflation, but we expect them to react eventually, especially if inflation starts to rise rapidly and shows signs of overshooting symmetric inflation targets.
Of course, that assumes they didn’t relinquish their independence a long time ago, and it also seems to assume that MMT will automatically lead to inflation so far above target that developed market central banks would be forced to lean against it. That is by no means a foregone conclusion.
Whatever the case, I thought readers might be interested in the following brief summary from Morgan’s global head of economics, Chetan Ahya. (For anyone steeped in this, there’s nothing “new” in the excerpts below, but they may serve as a useful pocket guide for some, and in any case, they speak to how pervasive this topic is becoming and how prominent it will feature in the post-COVID world).
From Morgan Stanley
What are the key propositions of MMT?
- Fiscal policy should be the primary tool for aggregate demand management: In a textbook on MMT published earlier this year, the authors argue that fiscal policy should be main tool to achieve economic objectives and describe MMT as a school of thought that “places the government at the center of the monetary system”.
- The central bank is not independent: In MMT, the central bank is part of the ‘consolidated government sector’ and provides direct funding to the government to accommodate spending as needed to reach its economic goals.
- The only check on government spending is inflation: As long as a country can borrow in its own currency, it doesn’t have any budgetary constraints as it can always print more money (in contrast to other economic agents such as households) to finance its spending. The only constraint to fiscal deficits and debt levels is inflation, which would require some adjustment in the fiscal stance. MMT proponents suggest that mechanisms can be put in place to ensure policies are adjusted to keep inflation under control.
What are the major deviations from the status quo?
The adoption of MMT would imply a permanent change in the institutional framework as it would make fiscal policy the primary tool for managing aggregate demand at all stages of the economic cycle. Central bank independence would be abolished, given that central banks would simply accommodate the fiscal policy swings. In other words, the central bank would engage in ‘monetary financing’. As this form of direct funding is currently not allowed in most jurisdictions (central banks can only buy and sell government bonds on the secondary market), this would imply that the institutional set-up and the associated governing laws would have to be changed.
Consequently, the government would take a greater role in the allocation of resources in the economy: Depending on the spending programmes, this could change the incentive structure for both government and nongovernment economic agents significantly. For instance, most prominently in emerging market economies, there have been instances where the public sector intervenes directly in the labour market or distorts lending behaviour by offering credit subsidies. This has tended to distort the incentive structure and how resources are allocated, resulting in macro-stability risks such as higher inflation and/or widening external balances.
Main challenges and critique of MMT
In our view, the primary issue is that adopting MMT would lead to concerns about the credibility of policy-makers’ ability to achieve price stability. Those concerns are driven by the following potential issues:
- Instilling discipline and long-term orientation in government policies: Fiscal spending programmes and tax policy will become even more heavily influenced by the political cycle, calling into question the ability and willingness of politicians to act on changes in the economic environment in a timely manner consistent with macroeconomic objectives such as maximum employment. Ensuring accountability for these policies would be a challenge, as a substantial lag could occur before the impact of a badly designed policy shows up in weaker productivity growth and inflation. Corrective action may also arrive with a significant lag, which could lead to greater volatility in key macroeconomic variables, such as growth and inflation.
- Erosion of inflation-fighting credibility: MMT argues that monetary policy should be conducted with the purpose of providing direct funding to the government. We believe that such a new institutional set-up will eliminate central bank independence. This will raise concerns about the credibility of preventing runaway or even hyperinflation, given that fiscal authorities historically have had a tendency to focus more on ensuring stronger growth in the near term, often at the expense of stable inflation.