This may shock you, but the Institute of International Finance was never a big fan of “modern monetary theory”, and has gleefully declared its death this year.
MMT became a hot topic when government debt kept ballooning around the world, even as long-term interest rates kept sagging lower and lower and inflation remained comatose.
That led MMT-ers to argue that governments could act FAR more aggressively to sort out a variety of societal ills. But as the second chart above shows, things now look a little different.
“The illusion of limitless fiscal space has ended abruptly in recent months,” the IIF’s chief economist Robin Brooks wrote in a report the lobbying organisation published Friday, pointing to the UK omnishambles as an example of how the market’s patience is not inexhaustible.
Yes, Japan still seems to have its foot to the pedal, but that then manifests itself in a collapsing currency, he argues.
Government debt had been rising steadily for many years even before COVID, yet interest rates were falling and — amid massive COVID debt issuance — remained low. This conundrum sparked debate on whether fiscal space in advanced economies is in fact limitless, making it possible to fund things like a universal basic income cheaply. The illusion of limitless fiscal space got a reality check in 2022. Japan had been a favored MMT talking point, given that it has been able to sustain high debt levels at low rates of interest.
However, this year’s inflation shock and global rise in interest rates exposed the risks to this high debt equilibrium: as global interest rates have risen, the fact that YCC has pegged Japan’s yields at low levels has meant that rate differentials moved sharply against Japan, sending the Yen into an unprecedented devaluation spiral. This illustrates that a central bank can suppress the fiscal risk premium in the bond market, but — if it does that — the risk premium just shows up in currency devaluation.
You can read the full report here. There are some more nice charts.
But FTAV can’t shake off the feeling that just as MMTers were too eager to embrace the most extreme interpretation of the low-rate era, MMT-foes are now being too eager to embrace simplistic narratives of bond vigilantes enforcing fiscal rectitude.
Source: Economy - ft.com
