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Are We About To Test Modern Monetary Theory?
Now that the Fed has lowered the Fed Funds rate to 0 from 25 basis points, I continue to hear pundits say that the Fed no longer has the ammunition needed to stimulate the economy should we slide into a recession due to the Coronavirus.
In my view, that statement is very short-sighted.
It does not make a difference if they do it now or a few months from now. Cheap money will be available for companies who need it either way. As such, I view all this criticism as unwarranted.
Instead, I focus on the fact that the Fed will not be alone in this battle to prop up the economy. They will be joined by the Congress and the President. This weekend, I read projections that put the size of the stimulus between $1 trillion and $1.4 trillion.
To put $1 trillion in perspective, moving backwards in time, 1 billion seconds would take us to about 1989. 1 trillion seconds would take us to around the year 30,000 BC. Said differently, if U.S. Treasury Secretary Mnuchin needed to count every dollar bill in $1 trillion of economic aid, it would take him 31,540 years of nonstop counting.
But the two questions that come to mind are - what else can the Federal Reserve do and where will the money for the stimulus come from?
The Fed can utilize Quantitative Easing (QE). Generally, QE is an effective tool to use especially when inflation is low. It was one of the ropes used to help us climb out of the abyss we were in during the financial crisis.
In QE, the Fed buys a specified amount of financial assets from banks and other financial institutions. This serves to raise the prices of those assets, thus lowering the yield while increasing the money supply in this country. The dual effects of lower interest rates and more money available could serve to pull the economy up if we are to fall into a recession due to the current situation.
The point is - with programs like QE and the emergency lending programs such as the ones they are currently involved in, the Fed is not out of ammunition.
Now let us take a look at our government. If Congress and the President are going to offer between $1 and $1.4 trillion in aid for corporations, small businesses, and those unemployed because of the virus, where will that come from?
Are we about to test Modern Monetary Theory (MMT)?
At its simplest core, MMT proposes that if a country has its own currency, the amount of debt it accumulates is generally not a concern because it can always print more money to pay its debt.
One of MMT’s foundations is John Maynard Keynes’, Paradox of Thrift. In essence, it says that, while a household in financial trouble can recover by cutting spending when their income falls, an economy cannot. One household’s spending is another household’s income. If in lean times everyone cuts back, no one is paid, and that could result in a severe recession.
Keynes argues that the only way out of this kind of financial trouble is through government intervention. Unlike the private sector, a government can spend freely, putting money back into each household and getting the economy back on track.
As such, you can argue that if we slide into a recession, government spending like the $1,200 per person based on income - although I imagine Keynes would argue to give it to everyone - may be doable. Plus, other programs currently under discussion can also be done.
Of course, MMT could cause runaway inflation and could have other impacts, but maybe we are now on the threshold of giving it a try.
The bottom line is this.
The Fed seems to be focused on the market function, its liquidity, and the credit crunch. The Government seems focused on the real economy, small business, big business, layoffs, and putting money in the hands of consumers who typically drive 68% - 70% of our economy.
In my view, whether through MMT or more conventional methods, if orchestrated correctly and acting in concert, the Fed and Washington could make any recessionary impact due to the Coronavirus short-lived.