Monetary Sovereignty is a spectrum: modern monetary theory and developing countries

Bonizzi's et al (2019) paper addresses and criticizes how Modern Monetary Theory (MMT) scholars set forth their assumptions and policy guidelines regarding developing and emerging countries (DECs).

The common ground between MMT advocates is the understanding that a state which issues its own currency and imposes tax liabilities; whose currency is fully floating and non-convertible; and whose country does not hold foreign-denominated debt liabilities—that is, a monetary sovereign state—can always run budget deficits to be financed through the issuance of public debt. Therefore, it can never run into insolvency.

Although the MMT core literature is focused on developed economies (especially the USA), scholars within such tradition have argued that its framework is also valid for DECs. However, DECs are much more vulnerable to external constraints (BP crises, sudden stops, currency depreciation, etc.) than advanced economies. This raises doubts on the extent to which they can act as monetary sovereign states as proposed by MMT authors.

Part of the MMT literature argues that there is no inherent economic constraint linked to trade and current account deficits (CAD) for monetary sovereign states. CADs would arise solely from foreigners’ desire to hold domestic currency-denominated assets and would not prevent a country from running budget deficits if it decided to do so. Other authors have a more nuanced view and believe there is a ‘spectrum’ of monetary sovereignty. A country is lower in this spectrum the higher its foreign-denominated debt is and the more limited its resources are, i.e. the more it lacks domestic production of foodstuff, energy, and manufactured goods. The low availability of resources pushes the country away from monetary sovereignty as foreign-debt and/or pegged exchange rate regimes are required to acquire such goods from other countries. Less sovereign states would not be able to benefit from MMT proposals, at least not as much as peers higher up in the monetary sovereignty spectrum.

The latter understanding opens up space for the pursuit of development policies focused on fostering the domestic productive structure in DECs. The authors are sympathetic to this, but argue that MMT scholars fall short from answering how these policies are to be funded as, at least in the short- and medium-run, they will require higher imports (technologies, capital goods, etc.) and, therefore, access to ‘hard currencies’.

There are three alternatives to achieve such a goal. Those are listed below alongside their challenges and shortcomings according to the authors:

1. Increase exports in a neo-mercantilist fashion. The problem with this strategy is that the necessary currency depreciation may be politically blocked as it requires wage compression and can raise risks of high cost-pushed inflation. It is also not a suitable alternative for every country as all countries cannot become net exporters at the same time.

2. Attract capital inflows. This can be highly problematic as FDI and portfolio investments in DECs tend to be quite sensitive to exchange rate expectations leading to currency volatility, fear of floating, and lower domestic control over macroeconomic variables. Higher foreign liabilities are also linked to future investment income outflows, deteriorating the current account result.

3. Rely on domestic financing through low-interest rates and development banks. The authors are sympathetic to this idea but highlight some shortcomings: the shallowness of domestic financial markets and the possible unwillingness of domestic agents to hold domestic currency-denominated assets (linked to capital flights).

Overall, the authors criticize the MMT theoretical framework for adding little to the long-debated need for development and industrial policies in DECs and for lacking the depth and complexity of other research traditions in this regard (e.g. in the Structuralist and Post-Keynesian literature). Likewise, they argue MMT lacks a structural understanding of international monetary and financial hierarchies which underpin the extent to which (especially DEC) countries are exposed to external constraints.

I believe this is a much welcome criticism of first world-centered literature. It comes with good timing. With Covid-19 and the post-pandemic recovery as the trending topic of the moment, the attention to DECs’ specific challenges is urgent and should take center stage for scholars and politicians alike.