Why can’t India spend like The USA, the answer lies the PARADOX called MMT

By Prof. Stanny Dias
Faculty of Management –Marketing

Post March there has been so much interest in the economic spending ( Stimulus) of each government towards mitigating the risks arising from the Post Covid Fallout.  See images for comparisons India (Right) vs. the World in terms of GDP

Image from Forbes.com and TOI

Countries like Japan, the USA have spend more than 13 % of their GDP which in itself dwarfs the spending of emerging countries like India ( 2%), Brazil etc. It has caused a lot of consternation and heart burn among economists and general public at large considering that the poorest reside in these developing or under developed countries like Africa. The poorest demand income support as their livelihoods are upended and the industries require direct cash support now to be viable in the future. However what has been offered by Indian government and RBI has been debt support at favourable interest rates and reforms which may come to fruition in long term. Not exactly rupees in each affected citizen’s bank accounts.

To understand why a rich US citizen can get a paycheque support of $1200 + $500 (child) per month in spite of being laid off vis a vis a migrant labourer in India who only gets a meagre Rs500 + basic rations, the answer lies in a paradox called as Modern Monetary theory or popularly known as MMT.

Standard Monetary theory posits that similar to households, governments can spend only if their citizens are productive and can pay back in taxes. The only drawback being that if the fiscal spending is more, then taxes are insufficient, therefore the government will issue bonds to borrow money but that comes at higher interest rates which percolates down to industries and individuals who have to pay higher interest rates thereby starving of growth capital to fuel growth. 

MMT in brief, argues that countries that issue their own currencies can never “run out of money” the way people or businesses can. Basically what it says is that the government can borrow as much as it needs and it will never default on payment as it can print more currency so long as it’s sovereign in its currency: that is, so long as it issues and controls the kind of money it taxes and spends and because it is the only agency allowed to create dollars. The only downside to printing more money is that there is risk of hyperinflation which can be damaging in the long run. To counter this government has a flexible tax policy which can drain the excess dollars from the market too cool the economy if there are warning signs.

Consider it as paradox but countries that borrow and pay in their own currencies like Japan and USA have an advantage over other countries that actually peg their currency against US dollars and have obligations to pay in foreign currency for all their imports and debt servicing.

The US till 1971 would benchmark its dollar against the gold standard but subsequently made it into a fiat currency i.e. the value of dollar is derived not from any specific asset but by the promise of the US government without which the dollars are just pieces of paper. So long as the world demands dollars which becomes a safe haven in terms of crisis, US will get away with printing more dollars without devaluing it.

Let me illustrate this with an example.

Consider the case of a US rich man with two kids and owning a big beach front property armed with all luxuries. These boys are entitled to monthly expenditure card worth $100 for indulging themselves. If this man wants his boys to do some household chores like make beds or mow the lawn etc, he offers them extra money $30 in addition to the monthly expense card as an incentive to do household chores but the additional money fails to motivate them as they already have enough cash.

Image from marketplace.org

Paradoxically he asks each of his sons to pay 20$ compulsorily from their expense card or complete certain household chores. Failure to pay the amount meant loss of certain privileges like shopping trips to Malls, access to swimming pools.  This was basically a kind of TAX which forces the boys to work in order to protect their monthly income. The rich man doesn’t need additional dollars but the TAX served a purpose of getting productive work done. Similarly countries like US, Japan who issue Fiat currency can print as many dollars to stimulate their economy and use direct and indirect taxes as a tool to keep inflation in check.

This, broadly speaking, is how the US monetary system works. It is true that the dollars in pocket are, in a physical sense, just pieces of paper. It’s the state’s ability to make and enforce its tax laws that sustains a demand for them, which in turn makes those dollars valuable.

Conclusion:
Unless the Indian Rupee actually becomes a true fiat currency whereby its value is not pegged to the US dollar, we are inhibited by prospective sovereign ratings downgrades thereby jeopardizing further foreign investments.

That’s the whole reason why our PM has given a call for economic Nationalism whereby every citizen should opt to buy only Indian products and conserve foreign exchange till a sunny day.

Countries like the US, Japan with fiscal deficits in excess of 18%  can get away with it by printing more currency and stimulating their economies much to the chagrin of emerging countries on account of the Modern Monetary theory

References

Soft Currency economics authored by Warren Mosler a wall street investor