Monetized Fiscal Expansion – Principles & Core Arguments. Conditions, Constraints, & Potential Implementation

Synopsis

There has been a clear shift towards growing acceptance of “unorthodox” stimulative fiscal economic policies lately as reflected in both The Economist and FT articles. One commonality running through various seemingly more “radical” economic stimulus policy recommendations consists of some form of central bank financed fiscal spending directed by either the government and/or via the central bank (MMT, Universal Income, People’s QE/Helicopter money, fiscal inflation targeting, central bank-financed fiscal deficit spending). This has led to an intensifying debate surrounding “monetized” fiscal expansion (defined as fiscal spending financed either via money creation and/or central bank purchases of government bonds). Please see appendix for a more thorough (macro accounting) treatment of the various forms of government financing. Proponents of such policies essentially argue that any sovereign government, which as a monopoly issuer of its own legal tender fiat currency, does not have a specific numerical budgetary limit; and hence can create/spend money to fulfil its policy objectives insofar as economic capacity exists and inflation is contained (no nominal constraint; only real). As such, there is a free lunch just waiting to be had, purely through the act of creating money. Exponents, on the contrary, argue that such policies will inevitably lead to runaway (hyper)inflation, invoking the ills of state-centric policy-making, capital mis-allocation, the “moral ills” of monetization and its adverse impact on “confidence”.

Most arguments, however, fail to comprehensively lay out the underlying conditions which will impact the degree of success/failure (policy appropriateness/suitability) of utilizing such “monetized” fiscal expansion policies. The outcome of such monetized fiscal policy strategy, we believe, in supporting sustainable economic growth depends crucially on the superstructure underlying the economy and can result in both success or failure. These include, i) domestic socio-political-economic structures, ii) global economic structure/financial architecture, iii) income distribution, iv) the shift of income, assets and liabilities among economic sectors/agents, v) quality/type of spending, and vi) the wealth stock capacity of the economy.

We provide a brief background and some core principles underlying monetized fiscal expansion. Further, we discuss the key conditions underlying success or failure of pursuing such an economic policy.

Fiat Currency

As first principles to understanding monetized fiscal expansion policies, one needs to recognize what fiat money truly reflects in this day and age. Fiat money has no intrinsic value; it has no maturity and is irredeemable in anything outside of itself. Money generally needs to fulfill three criteria, i) store of value, ii) unit of account, and iii) medium of exchange. The most important characteristics, in our view, underlying sovereign fiat’s “value” are (a) viability as a claim on present/future economic production (stability/growth of purchasing power and aggregate supply) and (b) the state’s ability to use coercion (supported by its institutions – tax office, banking/financial system, armed forces, etc) to enforce its primacy in the economy as the medium of exchange (deemed legal tender). Economically, money (and most other forms of public liabilities) is essentially society’s claim on its present/future economic production (with the form of public liabilities to an extent determined by the intertemporal choices of the issuer/holders). Public liabilities serve as society’s collective promise/liability to reciprocate (economic output) upon demand by its holder. Outside of its “tangible” value (in exchange for goods and services), money, to some, provides the fulfillment of more abstract, psychological benefits including power, influence, status, greed, or the pure pursuit of money as a game.

Money is the most liquid form of risk-free public “liabilities” vis-à-vis longer duration/less liquid bills/government bonds. An injection of which via central bank money creation (or via banks within the reserves system) expands the stock of monetary base with government debt issuance shrinking the monetary base (debt-financed fiscal spending, not absorbed via money creation by either the central bank/banks within the reserves system, does not lead to an expansion in monetary base).

Intellectual Background of Monetized Fiscal Expansion

Abba Lerner’s Functional Finance argues that government finance should be undertaken only in consideration of actual economic outcomes.

“…government fiscal policy, its spending and taxing, its borrowing and repayment of loans, its issue of new money and its withdrawal of money, shall all be undertaken with an eye only to the results of these actions on the economy and not to any established traditional doctrine about what is sound or unsound”.

The principal role of government finance should be to support the government in achieving its explicit policy objectives – managing the business cycle, achieving full employment, ensuring growth and price stability. In terms of government finance, taxation is never to be undertaken with the intention to fund government deficits, but rather, it must be judged only by its effect (discourages certain activities/behaviors) – primarily extracting money out of the economy, dampening economic activities. Meanwhile, the government should borrow money only if it is desirable to do so (when interest rates are too low amid high inflation risks). The national debt is of no policy concern insofar as the government maintains a proper level of demand for the current output level with price stability. Most importantly, the successful implementation of Functional Finance should lead to a stabilizing level of national debt with time (Higher public spending >> Higher private wealth >> Less need to save/lower indebtedness >> Higher private spending >> Less need to undertake public spending >> National debt stabilizing). Lerner also believes that there is a multiplier effect (> 1) to fiscal expansion – Keynesian economics.

Another key concept underpinning the foundation of monetized fiscal expansion is Wynne Godley’s flow-of-funds and sectoral balances approach. The basic underlying principle, as alluded by the macro sectoral accounting identity (Government Balance + Domestic Private Balance + Foreign Balance = 0), is that income-expenditure are two sides of the same coin (as per asset-liability and credit-debt). The accounting identity can never be violated since someone’s asset is another’s liability and someone’s expenditure is another’s income. With regards to government expenditure, its budgetary surplus/deficit simply mirrors the inverse of the country’s domestic private sector (households/corps/financials) balance, and its foreign balance (current account). Sectoral balances must sum to zero. It follows then, that an attempt to reduce the government deficit, for example, will necessarily see an erosion of the private sector (domestic + foreign) surplus, and vice versa.

This is not to say that intra-sectoral shifts are not important (negative economic impact of income/wealth disparity within private sectors) or that any specific sectors should be running a surplus/deficit at all times. It all depends on the phase of growth, imbalances and superstructures underlying the economies. What truly matters then, is not merely which sector runs a surplus/deficit, but rather how surpluses/deficits are generated and the subsequent implications on the economy’s growth/inflation.

In addition, it is important to state that the process underlying shifts in sectoral balances are complex and dynamic (multi-order impact) and that actions taken to force adjustments (shifting surpluses/deficits among sectors) may lead to outcomes that differs from partial analysis. Government austerity policy is one example where the explicit policy objective of reducing the fiscal deficit led instead to a further deterioration (multiplier effect from reduced government spending led to a disproportionately sharper drop in GDP, thus increasing the budget deficit).

Taken together, both Lerner’s and Godley’s works suggest that fiscal policy does not require “financing”, and when under-taken at an appropriate time, can serve to galvanize the private sector’s income and balance sheet by injecting net income and financial assets into the economy.

At this juncture, the most prominent school of thought under-lying monetized fiscal expansion is the Modern Monetary Theory (“MMT”), first traced back to Warren Mosler, an American economist and hedge fund manager, in the 1970s. MMT largely revolves around the role and creation of money in a fiat currency world and its subsequent implications for policymaking for both fiscal and monetary authorities. Many of the ideas raised by MMT are far from “modern” or “original” but are instead heavily influenced by pre-existing theories/schools of thought, including ideas from the above-mentioned Lerner and Godley (with their work, in turn, mostly extensions of ideas that have been well-developed by Keynes/Minsky/Kalecki/Levy).

MMT’s proponents generally agree on the following core principles:

a. A sovereign government which is a monopolistic issuer of its own fiat currency can choose not to default on debt denominated in its own currency via its ability to procure its own currency.

b. A sovereign government which is a monopolistic issuer of its own fiat currency can create money and spend without taxation revenue or raising government debt.

c. Inflation will arise only after the economy’s real resources are employed, rather than how much money is created.

d. Without risk of default in debt of its own currency, there are no financial constraints to government spending (the government can create money indefinitely). The only constraint is real economic constraint, reflected by inflation.

e. Given the state’s ability (enabled by its status as a currency ‘issuer’ rather than a ‘user’) to anchor nominal financing costs, the costs of government deficits, relative to other forms of debt/liability accumulation by private sector agents, are low.

f. The primary role of taxation is not to fund government spending, but rather, to use the power of the state to impose a tax liability payable in its own currency which creates a demand for the currency and gives it value. Taxation can also be used to influence income distribution, the managing of business cycles, or to create incentives for specific objectives (such as environmental protection/corporate investments).

The idea surrounding the role of taxation (f) stems from chartalism (that a currency only needs government-imposed taxation to derive its value) – we believe the point does not have much implications on either the key principles or policy prescriptions.

A core policy argument of MMT – widely discussed currently – entails the heavy use of fiscal policy to achieve full employment. This is now largely mainstream academic consensus post the Covid-19 pandemic; what is relatively more controversial is the unorthodox approaches to fiscal and monetary policy coordination/consolidation argued for by proponents. Fiscal policy, they believe, should be the primary tool utilized to manage the business cycle. They also largely disregard conventional ‘financial constraints’ such as fiscal deficits/budgetary targets over the medium-longer term (the only constraint is real economic resources – inflation). The notion that one needs to manage its fiscal deficits over the longer-run (balanced budget requirements) is rejected.

To implement such policies, proponents argue for a more intense and formalized coordination between the fiscal and monetary authorities. The monetary authorities (i.e. central banks) would mainly serve to facilitate government spending/tightening (in the form of balance sheet management via money creation/destruction), with monetary policy essentially subjugated to fiscal policy (fiscal dominance). Actual proposed implementation typically incorporates counter-cyclical mechanisms/automatic macroeconomic stabilizers – e.g. the job-guarantee schemes whereby the government acts as an employer of last resort is a dominant policy prescription in MMT literature.

Principles underlying Monetized Fiscal Expansion

Key principles underlying monetized fiscal expansion:

The impact and limits of monetized fiscal expansion can be worked through using the below formula which is a variant of MV = PQ,

W * Vw = P * Q (Nominal GDP)

The concepts of an economy’s wealth stock, W, wealth velocity, Vw, and capacity of “wealth” borrows from Jesse Livermore of Philosophical Economics (any error or misinterpretation are ours). It is slightly different from the traditional concept of money supply and its velocity in mainstream economics as it includes money + wealth held in other forms (other financial assets) which are readily convertible into money (dependent upon liquidity provided by financial markets).

The nominal GDP of an economy, at any juncture, is determined by the stock of wealth, W, of an economy and the velocity of wealth, Vw (rate at which wealth is exchanged in an economy). Nominal GDP rises if either the wealth stock increases, or if spending per unit of wealth increases. Whether nominal GDP adjusts largely through real growth or inflation depends on the economy’s wealth capacity (when an economy’s wealth capacity > wealth stock, there will not be inflationary pressures). To put it another way, an economy’s wealth capacity determines the inflation constraints of monetized fiscal expansion, while its wealth velocity determines the pace at which the economy reaches such constraints. Wealth velocity thus refers to spending/transactions per unit of ‘wealth’. Wealth capacity refers to the level of wealth stock where aggregate demand = utilization of productive resources before inflation constraints are breached.

With regards to monetized fiscal expansion, government deficits and thus debt (money) issuances expand the wealth stock, W, of the private sector. Hence, factors (superstructures of the economy; quality of fiscal spending) affecting wealth velocity and wealth capacity will determine the scope for utilizing monetized fiscal expansion with price stability. Output, Q, can be higher/constant/lower depending on how government spending is structured, marginal utility of labour/capital in production, income share of labour/capital, and capacity utilization and growth – all these factors impact Vw and subsequently to Q. It is important to note that all such analysis is highly complex and dynamic (Ceteris Paribas type analysis will invariably fail).

1. Prevalence of Wealth Hoarders

“The love of money as a possession — as distinguished from the love of money as a means to the enjoyments and realities of life — will be recognized for what it is, a somewhat disgusting morbidity, one of those semi-criminal, semi-pathological propensities which one hands over with a shudder to the specialists in mental disease.” – J.M. Keynes

Higher private sector wealth, reflecting fiscal expansion, can be hoarded instead of spent, depending on the type of government spending, the prevalence of wealth hoarders, and the distribution of income/wealth of the economy. Wealth hoarders are typically higher income households and capital owners, with low-to-zero marginal propensity to consume. Wealth is accumulated mostly for its intangible characteristics – status/power – with limited intention to consume; accumulation for the sake of accumulation. Such accumulation deprives the economy of demand (Vw falls) even as the wealth stock (W increases) expands.

Vw is more likely to fall (as wealth is hoarded), the more extensive the prevalence of wealth hoarders are in an economy (reflected in high wealth concentration and income disparity). This expands the economy’s wealth capacity, as the economy can hold more wealth per unit of additional government spending, as the net increase in wealth is hoarded rather than spent.

For example, tax rebates/tax cuts (higher government spending) for higher income households/corporates may lead to higher W, with limited corresponding impact on either P or Q, as most of the income is saved. This acts essentially as a net transfer of wealth from the government/public to such entities.

Alternatively, considering government direct handouts as a policy, in an economic environment of capacity abundance (labour and capital), low marginal cost of production, dominated by capital intensive production and high income share of capital (demand and income provided by cash handouts absorbed by rising production from idle capacity, owned and subsequently earned by higher income, low propensity to consume capital owners), both W and Q can increase, coupled with a fall in Vw, though to a lesser extent than the previous example – marginal propensity to consume is higher with direct handouts than poorly targeted tax cuts.

While the prevalence of wealth hoarders in an economy may extend the scope for non-inflationary, monetized fiscal expansion, nevertheless this may lead to other side effects. This creates the problem of indebted demand, where income earned from demand generated leads to purchasing power (claim on current/future resources) to be continuously transferred to high wealth entities with low-to-zero marginal propensity to consume, forcing the economy into a permanently low growth, low interest rate, high debt environment, retarding the impact on both fiscal and monetary policies. Further, it leads to higher financial instability as wealth hoarders may seek to rebalance their asset portfolio away from money/government debt, pushing other asset prices higher (Note the selling does not imply higher yields for government liabilities as demand for such instruments will remain high (liquidity, regulatory, diversification, etc), but will instead be reflected in higher asset prices elsewhere).

2. Share of Income and Degree of Wealth Recycling

Relatedly, as W expands, on the back of fiscal expansion, and assuming that it is spent, 2^nd-order spending (Keynesian multiplier) and its impact on Vw will be dependent on which entities – high/low marginal propensity to consume – earns the income (high/low propensity to consume sectors).

For example, corporates engaging in buybacks/acquiring other financial assets/M&As instead of expanding production or paying higher wages means that income will not be recycled back into the economy, but instead hoarded as wealth. This is dependent on factors such as quality of fiscal expansion, domestic/international tax regimes, industry and investment policies, and capital-labour bargaining power.

Vw will be lower and wealth capacity larger with higher income disparity and as the degree of wealth recycling declines. Alternatively, Vw will be higher should the income earned be skewed towards entities with higher marginal propensity to consume and as the degree of wealth recycling rises.

3. Impact of Global Financial Architecture and Exposure to Structural Dis-inflationary Drivers

An economy’s wealth capacity will be higher if it is exposed to more and stronger dis-inflationary drivers (globalization, import competition, automation and technology, labour bargaining position.

As discussed above, fiscal expansion can be ‘leaked’ abroad in the form of a larger current account deficit. This is especially so if the global financial architecture lacks automatic adjustment mechanisms that corrects sustained external imbalances. We have highlighted previously (here and here) about the problems behind the current global financial architecture (one which results in high external imbalances adjusting in a non-growth conducive manner). We have also argued extensively that there is a need for surplus economies to generate more domestic sources of demand. MMT literature, for example, largely focuses on domestic drivers. However, we deem it essential that any monetized fiscal expansion policy proposed be gauged within the context of the current global financial architecture and balance of payments backdrop. This determines the extent of income/demand (and domestic assets held by foreigners) leaked abroad. This can have massive implications with regards to the spending countries’ financial sovereignty (currency movements and its impact on domestic macro stability – inflation/financial stability) and its asset markets (foreigners play a decisive role in asset inflation/deflation through choice of domestic assets held).

4. Other Considerations

Government’s competency, stability and strength of institutions

An economy’s wealth capacity is positively linked to the government’s competency, stability, and strengths of its institutions.

Foreign borrowings

An economy’s wealth capacity will be lower if the proportion of foreign-currency based borrowings is higher (lower degree of currency sovereignty).

Conditions for a Free Lunch

Indeed, there is seemingly a free lunch – the government can create money and spend, without constraint, on all its policy objectives, insofar as inflation is kept on target. Since money is created from thin air and spent into the economy, there is a net gain in the financial wealth of the private sector theoretically without a corresponding private “liability”. To many, this sounds too good to be true and suggests that the state can spend itself into prosperity for all.

This, however, is only possible, if certain condition(s) are met. These include, i) demand creating its own supply, ii) productivity of the spending, and iii) proportional decline in wealth velocity vis-à-vis stock of wealth (as discussed above). The interaction between these three conditions will have implications over the sustainability of utilizing monetized fiscal expansion as a policy.

Demand creating its own supply. In a macro environment characterized by a scarcity of demand and underutilization of economic resources (real capital or labour) – reflected by low inflation, monetized fiscal expansion by creating demand can lead to an expansion in economic activity by utilizing un-used economic resources. The incremental demand generated is met by “idle” supply, with limited, if any, upward price pressures. If spending translates to higher income for economic entities with higher propensity to consume – through labour employment or capital constrained growth entities, the Keynesian multiplier (> 1) applies as spending leads to further consumption/investment (higher levels of recycled wealth and rising wealth velocity), leading to higher GDP growth.

Productivity of spending. Fiscal stimulus directed at productivity enhancing economic activities will be self-financing (self-liquidating liabilities) in that future production created will more than make up for the increase in government liabilities. Such public spending will be doubly effective in economies with a chronic shortfall of public investments – infrastructure, public works and services, providing ample scope for the economy to absorb productivity-enhancing spending which provides high returns. Opportunities for such spending are evident in DM economies, following years of neglect in public investments, reflecting economic policy dogma (“crowding out”) and years of austerity.

Importantly, the rise in money/debt growth, for the above two conditions, are thereby matched by an increase in GDP growth (essentially there is no increase in the ratio of future claims – money/debt – to economic resources – self-liquidating liabilities; Lerner’s “equilibrium” state).

Irrelevant Critiques

a. Hyperinflation/Price Instability without Proper Recognition of Underlying Conditions

Zimbabwe and the Weimar Republic (hyperinflation) being the most common examples; most arguments do not lay out the conditions under which these examples apply (see J.Montier). Arguments citing the sudden loss of “confidence” leading to runaway inflation can be safely ignored, considering the lack of analytical rigor.

b. Growth in Money Supply (monetarists) as “Sufficient” Determinant of Inflation

“It is also evident, that the prices do not so much depend on the absolute quantity of commodities and that of money, which are in a nation, as on that of the commodities, which come or may come to market, and of the money which circulates. If the coin be locked up in chests, it is the same thing with regard to prices, as if it were annihilated; if the commodities be hoarded in magazines and granaries, a like effect follows. As the money and commodities in these cases never meet, they cannot affect each other.” – David Hume, Essays, Moral, Political, Literary, “Of Money“, 1741 [bold emphasis ours].

It remains quite perplexing as to why this remains a legitimate argument given the empirically weak relationship between money supply and inflation, particularly in recent years. As highlighted by Hume, an increase in the stock of money, by itself, is not enough to cause an increase in prices (though, sadly, this has never prevented proponents from plotting charts of M2 growth and arguing otherwise). As Hume so vividly portrayed, coins (wealth) can be locked up in chests, sank to the bottom of the deepest of oceans and essentially annihilated forever. For monetized fiscal expansion to be inflationary, growth in money stock must subsequently lead to an increase in spending (i.e. growth in the stock of wealth must translate into real demand for goods and services). Essentially, this depends largely on how and to whom such policies are targeted. If such policies do not lead to meaningful increases in spending, then they will not significantly affect aggregate supply/demand dynamics – which in turn determine prices. In fact, monetized fiscal expansion can be deflationary when targeted at indebted/unproductive/low propensity to consume entities (China and Japan are variants of such examples though both reflect different drivers).

To re-iterate, monetized fiscal expansion can subsequently be spent/saved (domestically/externally) or used to meet expenses/extinguish liabilities. It depends on the dominant superstructure of the domestic economy and the underlying conditions and context. One can consume, save, recycle cash into financial assets, or invest in the ‘real economy’. It is abundantly clear that each will have a different implication on growth and inflation of an economy. Inflationary pressures will only build when excessive demand is placed on the economy’s labor and capital resources (aggregate demand > supply). Essentially, the only variable that matters for inflation is aggregate total income that is spent or invested (in real resources). Income subsequently held as savings does not place any demand on real resources, and therefore has no effect on prices. Large government deficits can certainly be used to finance excessive spending leading to inflationary outcomes. However, in cases where monetized fiscal expansion is not excessive, either because of the existence of a sizeable output gap or when proceeds are saved, the result will not be inflationary

c. Fiscal Deficits Leads to Higher Interest Rates as Sovereign Solvency is Questioned

Monetary authorities retain the ability to control nominal interest rates directly or indirectly (such as a credible YCC regime). The direction of real rates, hence, can be entirely dependent on inflation dynamics.

Even if left entirely to market forces, high government debt levels and low interest rates may at times correspond as they reflect similar drivers. For example, persistently weak nominal economic growth augurs for lower interest rates, while debt-to-GDP ratio itself often grows faster as the denominator stalls (evident in most G10 economies). One thus should not immediately relate higher government debt accumulation to higher interest rates. Supply dynamics (a function of fiscal policy and the treasury’s issuance plans) have no direct relation to UST yields (one can simply plot a chart of fiscal deficits and/or government debt against treasury yields to be convinced) – rather neutral and terminal rates expectations reflecting longer-term growth/inflation dynamics and the directionality of term premia are the dominant drivers.

Important Considerations

a. Political Constraints

Monetized fiscal expansion, to us, is simply another economic policy tool. A select group of economies (given their underlying structures/conditions) have the policy option to utilize such a fiscal expansion policy when the circumstances are appropriate. The practical constraint, outside of those discussed earlier, remains political in nature, as opposed to the technicalities. Ultimately, for such policies to be enacted effectively will entail a significant re-evaluation of the relationships and power dynamics between the government (which comprises of both the treasury and the central bank), domestic corporates and financials, elites, capital, labour, and the external sector. This can only be resolved via the political process which needs to satisfy, in aggregate, each country’s unique circumstances. As argued, political outcomes will impact both the quality and distributional effects of fiscal spending, ending in either a growth-conducive/non-conducive manner. For example, MMT trivializes the political complexities underlying fiscal-monetary coordination, which obviously requires a meaningful shift in dynamics which may not be probable. This is notwithstanding the complicated political struggles among different interest groups due to self-interests, ideologies, class, wealth, and social-standing.

b. Fiscal Profligacy

Proponents of monetized fiscal expansion may have placed too much faith in fiscal policymakers’ capacity and willingness to properly manage the economic system. Indeed, there continues to be a lack of well thought out actionable policies which, for example, mitigates political capture by the executive or allows for the automatic adjustments of counter-cyclical spending policies.

c. Practicalities of a Federal Job Guarantee

MMT proponents argue for the government to act as an employer of last resort (targeting full employment and determining the effective wage floor). However, this assumes an abundance of productive jobs which otherwise will not have been available unless provided for by the federal government. A side effect of such policy may be the rise of market-distorting, unproductive wages, which in turn structurally erodes the economy’s competitiveness. This is notwithstanding the administrative complexities of running such a program

d. Super-Structures

We have argued that the sustainability of monetized fiscal expansion will depend on both the quality and distributional impact of fiscal spending (beyond the 1^st order impact). Both factors are highly influenced by the global/domestic super-structures with the impact of expansion policies introduced differing based on the unique conditions and circumstances underlying each economy (explained through the example of the US below)

e. Financial Markets and Cycles

We have argued earlier that the recycling of income/wealth primarily back into financial assets has limited transmission to the real economy (both aggregate demand and supply), this relates to the underlying incentive structures of financial markets/intermediaries. Hence, policy efficacy will be partially determined by >2^nd order spending decisions (buy-back/M&As vis-à-vis real investments), global taxation regimes, as well as concentration of real/financial assets ownership, for instance.

Fiscal-Monetary Policy Coordination and Monetized Fiscal Expansion, in the context of the US Economy

We explore various potential forms of fiscal-monetary policy coordination and implementation of monetized fiscal expansion. Using the US economy as a short example, we conclude that a poorly designed, untargeted, monetized fiscal expansion program by US policy-makers will be far from being a panacea to economic growth, considering the current macroeconomic context and underlying super-structures.

Fiscal-monetary policy coordination and forms of implementation of monetized fiscal expansion

With regards to global fiscal-monetary policy alignment, much of the world, we believe, is currently already at the most foundational level of policy coordination. This entails a tacit understanding from both set of policy-makers that circumstances warrant an alignment of fiscal and monetary policies, each should work to reinforce one another. While, monetary and fiscal policy-makers may, at times, have contradictory goals, the objective of supporting the economy is commonly held by both. This may require both fiscal and monetary authorities to be strongly aligned at times. Hence, room exists for coordinated policy responses while still upholding policy independence.

Such a regime is currently in place in the US (though may be temporary). The AIT-framework, as argued, provides a credible assurance that fiscal spending will not be contradicted by tight monetary policy from the Fed (implicit fiscal-monetary policy coordination). Meanwhile, US domestic politics also increasingly favor expansionary fiscal policy and income transfers to the lower income class. The coordination between the Abenomics and the BoJ is also an example of such coordination.

Going beyond the foundational level of fiscal-monetary policy coordination will require a more extensive comingling of monetary and fiscal policy. This will entail CBs ceding monetary authority to fiscal policy-makers (fiscal dominance), effectively subordinating its own policy independence, at least temporarily, to fiscal policy-makers. A closer form of fiscal-monetary policy coordination, for example, can be broadly categorized as direct monetary financing of the Treasury and/or interest rate pegs – both of which have been pursued in the past.

Effective YCC was implemented during WWII to support war efforts. The Fed formally committed to an interest-rate peg of 0.375% on short-term Treasury bills in April-1942, and also capped the interest rate on long-term Treasury bonds (=>25 years) at 2.50%. To maintain YCC credibility, the Fed essentially gave up control of its balance sheet size and the corresponding money stock. Interest rate targeting was eventually brought to an end by the Treasury-Fed Accord in March 1951.

Direct monetary financing was also utilized post-WWII when the 1942 Second War Powers Act was enacted. The Act provided an exemption to the 1935 Banking Act (which prohibited direct Fed purchases of treasuries), thereby allowing the Federal Reserve to directly purchase treasury securities (up to a maximum of USD 5bn), bypassing financial constraints – the modern day analogy will be the UK’s “Ways and Means” facility. This authority lapsed in 1981. Since then, the Fed is no longer allowed to lend directly to the Treasury.

A more modern, rules-based, form of fiscal-monetary coordination would be to align both fiscal and monetary policies trajectory to macroeconomic targets/thresholds (growth/inflation/unemployment),. This approach circumvents the, at times, messy and cumbersome, political process which may hinder counter-cyclical fiscal policy. The ‘Sahm Rule’ (recession indicator), for example, can act as the trigger for immediate fiscal stimulus when monetary policy is close to the ELB. Finally, there may be future means – enabled by technology – whereby the CB can bypass the banking system, at least initially (through central bank digital currency), and inject cash directly to targeted recipients.

Monetized Fiscal Expansion in the Context of the US Economy

As argued, the impact of monetized fiscal expansion depends largely on context, underlying conditions, and the overriding superstructures underlying each economy. In the context of the US, monetized fiscal expansion will create stronger demand if targeted at money/credit constrained entities. High unemployment and low inflation exacerbated by the Covid-19 pandemic points to low utilization of economic resources, especially labour. Hence, demand, we believe, is likely to create its own supply through higher employment and capacity utilization – real GDP expansion with benign inflationary pressures. Stimulus will be more impactful for the domestic low productivity services/consumption-based sectors (as the economy starts opening up from Covid-19) – lowering unemployment and leading to higher services inflation (the extent depending on the magnitude of stimulus provided).

However, the superstructures under-lying the US economy – high concentration of wealth, narrow ownership of the factors of production, low global marginal costs of real/financial supply production, suggests that 2nd-order multipliers will not be high (close to zero) should such conditions remain entrenched (wealth will be hoarded). Further, the US is likely to see significant demand leakage, coming through in the form of a widening current account deficit (as already evidenced by rising current account surpluses in surplus economies following the pandemic relief package).

Most significantly, the use of monetized fiscal expansion policies without major changes in both domestic and global economic structures (shifts in income share, labour/industrial policy, real investment, employment beta to growth, anti-trust, corporate/managerial class taxation and welfare reforms, reform of global financial architecture – especially the bancor initiative) will not, we believe, be able to revive the US economy sustainably. A well-designed systematic strategy which encompasses socio-economic, financial and geo-political reforms are required, rather than just domestic demand side management policies.

Conclusion

Academic evolution and its influence on policy-making have always been circumstantial (material interactions/constraints) throughout history. A shift has occurred, we believe, in economic consensus that neo-liberalism has failed in delivering sustainable economic prosperity for all (though we suspect that neo-liberal elites, to stay relevant, are seeking to revamp and co-opt other schools of thought). The same applies to Friedman’s monetarism and the dominance of central banking over economic and financial policies. There is no “end of history”. We support the premise that monetized fiscal expansion is simply a matter of policy choice for governments that are monopoly issuers of fiat currency, operating under specific circumstances as described. We strongly endorsed the framework that macroeconomic policies, including fiscal, should always be analyzed in aggregate (flow-of-funds and sectoral balance approach), considering only actual outcomes (which admittedly can be multi-faceted, considering the complexity of understanding the impact on a sovereign’s superstructures). As per Lerner, macroeconomic policies “shall all be undertaken with an eye only to the results of these actions… not to any established traditional doctrine about what is sound or unsound”, where sound and unsound to us purely reflects one’s ideological leanings and preferences of each economic-socio-political structure (material constraints).

We appreciate the potential benefits of introducing monetized fiscal expansion as part of the macro policy toolkit. First, its efficacy in achieving inflation targets is, we believe, more effective vis-à-vis other forms of policy. The current global context also warrants a larger fiscal response, coupled with synchronized monetary policy-making (the pandemic has inevitably triggered an era of fiscal-monetary coordination globally, to varying degrees). A well-targeted fiscal stimulus program can also help address structural issues plaguing the global economy, such as unemployment, income inequality and addressing longer term global challenges such as climate change.

Yet, monetized fiscal spending is far from a panacea to achieve global prosperity. In essence, whether spending will be conducive for sustainable future growth depends on the prevailing “return on assets” (RoA) vs the “cost of liabilities” (CoL) for the economy (the appendix illustrates how assets/liabilities shift across different macroeconomic agents). While, technically, the monetary authority can suppress nominal interest rates infinitely, the CoL may increase via other channels – including inflation, financial instability, indebted demand coupled with minimal growth/inflation. Critiques include the trivialization of political constraints and the downplaying of its short-comings (political dominance, fiscal indiscipline, impact on aggregate supply due to skewed incentives, practicality). MMT policy recommendations such as a federal job guarantee lacks practicality. Most importantly, proponents do not comprehensively lay out the underlying conditions and circumstances whereby monetized fiscal expansion can be most effective/counter-productive. These become obvious once we consider superstructures which affect the quality and distributional impact of spending (impact on wealth velocity/capacities; aggregate supply/demand responses; >2^nd order impact and the sustainability of such policies).