The radical solution to Pakistan’s slowing economy: print more money. Simple!

At first glance, there is not much that unites Stephanie Kelton and Asad Zaman. One is hyper-American – the kind of fast talking, uber confident person that responds well to rapid-fire questions on CNBC. The other is a scholarly-looking, soft-spoken Pakistani uncle, who gives detailed and sober presentations at the State Bank of Pakistan. One is the current economic advisor to United States presidential candidate Bernie Sanders. The other serves as an external member on Pakistan’s Monetary Policy Committee. One talks about restructuring capitalism; the other espouses the virtues of Islamic economics.

But in one key aspect, the two economists are very similar: they are both proponents of the controversial economic theory, the Modern Monetary Theory (MMT).

Depending on who you ask, MMT is either the best idea economists have come up with in the last decade, or the worst.  It is also a very American economic idea – and this is important in explaining its meteoric rise in global consciousness in the last year alone. Kelton promoted the idea in as many media outlets as she could. 

According to Bloomberg, Google searches for MMT more than quadrupled in 2019, in part because of Kelton’s advocacy. That she is also Bernie Sanders’ advisor has not won her good will with sections of the American right. Then, of course, the highly popular and visible leftist US Congresswoman Alexandria Ocasio-Cortez said in January 2019 that MMT “absolutely” needs to be “a larger part of our conversation” – furthering the attention that MMT received.

Okay, so the world's biggest economy is having an existential academic crisis about a wacky economic theory – so what? Well, because a prominent Pakistani economist believes it too and has been advocating that the government of Pakistan consider its implications. Even scarier than one lone economist championing this theory? It plays to the Finance Ministry’s biases and might just end up giving them the academic fig leaf they need to pursue their wreckless policies. 

Zaman is no stranger to the West. He left for Boston at the age of 16 to attend the Massachusetts Institute of Technology in 1971. After completing his bachelors in mathematics, he then went on to complete a masters in statistics and a PhD in economics at Stanford University.

After teaching at the University of Pennsylvania and Columbia University, he had a mild religious pivot, and spent the last few years enthusiastically discussing an Islamic approach to economics in Pakistan. Most recently, he was the Vice Chancellor at Pakistani Institute of Development Economics (PIDE), serving a five-year term ending in March 2019.

Zaman is not afraid of being unconventional, or of showing unwavering belief in an idea (few economists around the world, for instance, would promote such a blatant hodge podge of  religion and economics). But now, instead of defending Islamic finance, he is defending MMT – just like Kelton.

When he first heard of the idea around five years ago, Zaman thought it “initially seemed really crazy”. But then, “a lot of things started to make sense.”  Speaking to Profit, he said, “MMT has many different little pieces, like a puzzle. Any one of them doesn’t make sense in isolation.”

And he has an audience – Zaman first gave a seminar on MMT in March 2019 at the State Bank of Pakistan, attended by the then Governor Tariq Bajwa. [Note: the SBP allowing a seminar is not an endorsement by the SBP of MMT]. He then gave his second seminar in January 2020, to a larger audience of around 60 people. 

Is that a worrisome development? Not particularly, but it is worth talking about. 

But first: what is MMT?

Think back to when you were a child and were given pocket money by your family. You must have wondered – what if I did not have to rely on my parents for my fixed pocket money? What if I had an endless supply of pocket money, or I could just wish for more money instead? How many more toys or ice creams could I afford then?

MMT, at its core, aims to answer exactly that question: what would a society or an economy look like if money was not a constraint? What if there was an infinite pile of money that a government could rely on?

Trying to answer this philosophical question is a little confusing, so bear with us. Basically, MMT upends conventional thinking in two ways.

One, MMT asks us to change our understanding of what money is. Ask any student of economics in high school what money is, and they will give the standard response: “Money is a medium of exchange evolved from systems of barter”. But in reality, money is not just that. Money is, well, money, because the government is choosing to print a currency. Money does not just have value because it represents a commodity – money has value because the government recognizes it as legal tender. In a sense, money is in fact a standard of deferred payment, with the government ‘making’ money by injecting it into the system, and ‘reclaiming’ money through taxation. Essentially, the government ‘makes’ money every time it spends money.

Secondly, MMT proposes that a government's budget is also different from conventional macroeconomic thinking. A typical household or person allocates a budget; that is, how much income they are receiving, and how much of that income they are spending or saving. In the same vein, conventionally we are taught that a government raises taxes from people, in order to spend money on different projects. If the government spends more money than it earns in taxation, it runs a deficit. 

According to MMT proponents, there are no budget constraints on the government because of that first point: that the government is the creator of money. This means that the government can not only run a deficit – the deficit does not matter. 

Instead of raising taxes in order to spend, the government makes money when it spends. In this scenario, taxation then becomes less of a tool of raising funds, and more a tool of managing excess demand or supply in a system. Instead, what is really propelling the system is deficit-based financing. 

It is not to say that the deficit is totally irrelevant. According to Zaman, “The deficit does have some significance, but it’s just that the government never has to pay back the deficit.” According to Dr Zaman, the US has a deficit that runs in the trillions. But fundamentally, “It’s just a number on the books”.

One can see why this theory is so alluring. If there are no real constraints on the money supply, and the deficit is not a concern, then imagine the possibilities. As a New Yorker article on Kelton points out: “On MMT blogs and on MMT Twitter, adherents imagine a world built on MMT principles, in which the government provides guaranteed jobs, health care, and affordable college, and launches clean infrastructure projects to replace our crumbling highways, airports, and bridges.”

MMT has a few key caveats. The country has to issue its own currency. So the United States could implement MMT, since it prints dollars, but France, which is under the Euro, cannot. (Pakistan can as well, since it issues the Pakistani rupee, but more on that later).

According to Dylan Matthews at Vox: “MMTers...argue that the government should never have to default 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. The US government, for instance...can’t run out of dollars, because it is the only agency allowed to create dollars.”

So if the constraint is not money, what is? Well, it is actually our resource constraint. 

“We say, we can’t invest in development projects because we don't have money,” explains Zaman. “This is completely wrong.” Under MMT, the government can choose to spend money on underutilized resources, or underdeveloped sectors. The extra money will spur development, and create extra demand, which will in turn create supply, so the thinking goes. 

Another salient feature under MMT is the idea of a job guarantee – that the government can offer jobs at minimum wage as a right of citizenship, which is how it will be able to achieve full employment. 

Okay, so the deficit is not important, full employment is possible, and the money supply is increasing: at this point you might be wondering: what about inflation? What is stopping any country from becoming Zimbabwe?

For an MMT proponent, inflation is not a top priority. Inflation is more a mismatch of demand and supply. Kelton believes in sustainable inflation, and that government spending is only responsible for a very small part of inflation. Instead, with accurate forecasting of inflation risk, and prudent government spending, inflation can be managed. Inflation becomes a risk only when the economy is at full employment (because of the job guarantee), and that is when taxation comes in handy. Instead of being used to raise funds, it is used to remove excess money from circulation.

Note the circularity of the logic there: the government should not have to worry about raising taxes in order to pay for its spending and instead just print the money instead. And what should it do when its money-printing results in inflation? Oh, just tax people to reduce inflation. Well, then what is wrong with taxing them in the first place to raise the money for government spending and not risk inflation to begin with?

What about interest rates? Well MMT proponents also have a bone to pick with the conventional model.  Traditionally, the bigger a deficit – such as in an MMT model – the more the government has to borrow, which will lead to higher interest rates. And also traditionally, the higher the interest rate, the lower the demand.

But MMT folks question that relationship, and point out that in fact, demand can be somewhat insensitive to interest rate changes. Kelton argues that cutting interest rates is ineffective in a slump, as some business and customers will not invest even at very low interest rates. 

And according to MMT, a budget deficit does not actually lead to higher interest rates. In fact, one New York Times article noted that several money managers on Wall Street were noticing the opposite in  the United States: that despite a roaring deficit, interest rates have been historically low. 

So what is the goal? Forget about interest rates. Instead, one could just set the interest rate at zero. An interest rate target for a government, in this scenario, is basically irrelevant. 

Essentially, instead of having a separate monetary and fiscal policy, under MMT you end up with just a fiscal policy – with the added bonus of never running out of money, since you can always print more anyway. Needless to say, in this scenario, the central bank no longer needs to be independent of the government.

What does that look like in Pakistan?

Take a breather, because there is a little more theory to digest. We have understood what it could look like in the United States, but how on earth could this possibly be applied to Pakistan?

The first big difference between Pakistan and the US, is that since the US prints dollars, it can print arbitrary amounts of money without risk of inflation, and therefore can run arbitrarily high trade deficits as well. Every other country needs to run current account surpluses to earn dollars, to use for imports and reserves.

This, as Zaman puts it, is a global trading system that is asymmetric, where countries have to increase exports to ever be able to run a trade surplus. This is a problem for a country like Pakistan, which has always found it challenging to increase its exports.

This entire system, as far as Zaman is concerned, is “very silly indeed”.

The other problem is that MMT works for a closed system – that is, a government cannot have  liabilities in foreign exchange. That is because under MMT, Pakistan is the sovereign issuer of the rupee, and therefore can print as much of it as it wants (and under MMT rules, will not go bankrupt). However, the government cannot print other countries’ currencies, and a portion of Pakistan’s debt and debt repayments are in dollars.

At this point you are probably thinking MMT is just not for us. But actually, Zaman believes MMT can still offer some solutions to a dollar-starved country like Pakistan. 

Since actually achieving a trade surplus is not possible, and foreign exchange reserves are a concern, the trick is to implement MMT in such a way that it does not upset the balance. Besides, Zaman said, “Pakistan’s foreign exchange situation is not so critical anymore.” (This is despite the most recent SBP Quarterly Report suggesting otherwise).

The first step is to get a handle on the exchange rate. If the government generates extra money, but also keeps the dollar undervalued, then import demand increases, and Pakistan’s balance of payments worsens. Instead, over value the dollar, and keep it higher than the equilibrium, thereby creating a transparent tax on imports in dollars. There is still excess demand for imports, because of the excess money supply,  but the balance of payments will actually be strengthened. While in the short term this will be negative, in the long run, viable import substitution might actually happen. 

Secondly, deficit spending can be encouraged. Under MMT, the deficit cannot create a balance payments problem as long as it is the domestic currency. What Zaman wants is strategic, targeted government spending on currently underutilized sectors of the economy. For him, that includes a massive injection of money into the education sector in order to improve human capital. This would be in the form of 30-year education loans that will be provided by the private sector, but backed by a sovereign guarantee. 

Next, similar to the job guarantee idea abroad, Zaman suggests providing productive jobs to people in Pakistan. Not only will employment rise, but extra demand will be generated and also extra products. These jobs would cater to the bottom of the labour pool, which is currently an ‘underutilized resource’. This includes community service, basic literacy training, planting trees, green conversion projects and preservation of forests.

The rise in jobs of course will lead to extra demand, but can be managed as long as “sufficient additional resources are directed to relevant sectors where excess demand will be generated.” And like his fellow MMT supporters in the US, Zaman is not too fussed about inflation. Relative inflation will take place and is to be welcomed, since price mechanism will kick in, signalling excess demand that will generate a response in supply.

Through MMT, the possibility of self-financing mega projects in Pakistan actually becomes a reality. Zaman envisions debt-financed roads, and public-works programs. Pakistan could create eco-cities the way China has. The government project for small rural business “Eik Hunar Eik Nagar”, could be rapidly expanded. Tourism could actually be developed.  

Zaman also proposes a ‘nudge’ to the private sector under MMT. Because of the current system, high interest rates are actually a threat to growth because the private sector prefers investing in insurance or real estate instead of ‘real investments’ like the ones listed above. Instead, Zaman proposes the government nudge the private sector to introduce directed lending programs, aligning their incentives with long run social prosperity.

So in short, this is what MMT in Pakistan could look like: we can spend money by recognizing that if a development project is viable, we can ‘borrow’ from future revenues and ‘create’ and invest money today. As long as Pakistan can manage its foreign exchange liabilities, and its domestic demand, Zaman sees no reason for why this model cannot work.

Zaman’s version of MMT is not as much a rebellion against traditional macroeconomic theory, as it is a political stance against the International Monetary Fund (IMF). For him, “we are still colonized by the IMF.” Zaman believes that the role of the IMF is to make sure the richest countries of the world make some of the poorest countries in the world pay interest payments on debt and reparations.

“The IMF is in the business of austerity and they impose it on poor countries, thereby keeping their economies enslaved to rich countries.” For Zaman, MMT could offer a way to escape from this trap. 

Not convinced? Do not worry, neither are these people 

Colonization theories aside, a lot of people have issues with this theory. First, the Americans: liberal macroeconomist and Nobel laureate Paul Krugman, Chair of the Federal Reserve Jerome Powell, billionaire Bill Gates, and former IMF chief economist Kenneth Rogoff. 

Just last December, the conservative American economist Gregory Mankiw, published a paper titled “A Skeptic’s Guide to Modern Monetary Theory”. It begins with a disclaimer: “Perhaps after forty years in the profession, I am too steeped in mainstream macroeconomics to fully appreciate MMT”, but still, he tries. 

First, he questions the assumption that under MMT there is no default risk associated with government debt. He writes that the expansion in the monetary base will increase bank lending and the money supply, which will lead to hyperinflation. “Faced with these circumstances, a government may decide that defaulting on its debts is the best option, despite its ability to create more money. That is, government default may occur not because it is inevitable but because it is preferable to hyperinflation,” the paper reads.

He also questions the MMT assumption that there is little link between inflation and an increase in money supply. In fact, he says: “This assertion overstates the case against the mainstream view. In U.S. decadal data since 1870, the correlation between inflation and money growth is 0.79.”

He also explains a little about inflation: “Inflation tends to rise when output and employment exceed their natural levels.” This is because price setters do not aim to maximize social welfare, they want to maximize profits. An MMT economist could fix that problem by using government price guidelines or price controls. But Mankiw argues: “the complexity of the economy and the history of price controls suggest that this solution is not practical.”

That final sentence could also be applied to Pakistan: are Zaman’s views – that we can adequately control inflation and foreign exchange reserves and spend money strategically – actually practical? Does the Pakistani government have enough resources to be able to manage such an economy, or the regulation to ‘nudge’ the private sector at its will?

One Pakistani economist based in the United States, who did not wish to be named out of respect for Zaman, nonetheless emailed Profit a two-page rebuttal expressing their concern with the theory. Dubbing MMT in Pakistan “an absolute nightmare”, they wrote that the central bank does not have “as much independence from the vagaries of politics” in South Asia as a whole, and in Pakistan in particular. 

“Our CB governors are appointed and shown the door without much due process, have historically been non-monetary economist types… problems at the Reserve Bank of India with Raghu[ram Raja] and Urjit [Patel] are even better examples of these issues. We've already had many bouts of double digit inflation due to political influence in the conduct of monetary policy. Allowing the CB to print money as part of its policy is just going to make this even worse.” they wrote. 

As for the underutilization of resources, a key tenet of MMT, they wrote: “it is true that the Pakistani economy has a lot of capacity. But is monetary policy the constraint hindering increase in productivity? Probably not, given that a lot of the economy is in the shadows. Our productivity is low probably because of all sorts of other constraints including missing financial markets (such as a futures market), marginalization of women in terms of labor force participation, and so on.”

So what’s next?

To be clear, at no point is the State Bank of Pakistan at all advocating such a radical approach to macroeconomics. Of course, we could not implement it even if we wanted to, what with the IMF bailout conditions. But the idea is still out there, despite heavy resistance. At the end of the MMT  seminar at the State Bank, several members of the SBP seemed quite skeptical, and lobbed questions at Zaman. Many kept coming back to the same point: concern about inflation or hyperinflation, particularly in food supplies in Pakistan. 

When asked about the push back, Zaman smiled, and said it was inevitable. “It is a pretty new concept, you have to be willing to experiment.” As a somewhat contrarian economist, he is also perhaps used to the pushback. Perhaps due to his own religious bent, he frames the fight about MMT as a battle between good and evil. 

That kind of unwavering belief and determinedness in a theory may suit Zaman well. But the implications such a theory might have for Pakistan are still a little up in the air.