Roaring into Recession; Universal Basic Income, and Modern Monetary Theory
Updated: Jul 5, 2020
by Navya Rana and Rohan Arora “There is a rising probability that large parts of the global economy will slip into recession… Yet, it is worthwhile to remember that tough times never last; only tough people and tough institutions do.” - Shaktikanta Das, Governor of the RBI, Monetary Policy Statement of March 27 As an already struggling Indian economy comes to a screeching halt to prevent the COVID-19 pandemic, a recession seems imminent to most experts. Financial markets have readjusted to record lows, falling about 30% since the year started; destroying a significant portion of the investors’ wealth and retirement savings. The Rupee, sinking against the USD, has breached the 77 mark (as of April 1, 2020) whilst the Dollar becomes a safe haven as imports fall. Internally, it is believed that unemployment—already a controversial topic— will enter dire straits as the impact hits and layoffs begin (estimates believe about 136 million to be at risk). Finally, growth estimates for the Indian GDP have now come down to 3-4% (some scholars even assert a meagre 2%) from the earlier forecast of 5-6% for FY21.
Should sufficient control not be established over the spread of the virus in the next few months, these facets, inter alia, are likely to deteriorate even further and the posterity might witness a contraction of the economy.
To focus onto why the Indian economy is especially vulnerable as it enters this crisis, we must look back at its performance over the last decade, as explained succinctly by Arvind Subramaniam: “In the immediate aftermath of the Global Financial Crisis (GFC), two key drivers of growth decelerated. Export growth slowed sharply as world trade stagnated, while investment fell victim to a home-grown Balance Sheet crisis, which came in two waves. The first wave—the Twin Balance Sheet crisis, encompassing banks and infrastructure companies—arrived when the infrastructure projects started during India’s investment boom of the mid-2000s began to go sour. The economy nonetheless continued to grow, despite temporary, adverse demonetization and GST shocks, propelled first by income gains from the large fall in international oil prices, then by government spending and a non-bank financial company (NBFC)-led credit boom. This credit boom financed unsustainable real estate inventory accumulation, inflating a bubble that finally burst in 2019. Consequently, consumption too has now sputtered, causing growth to collapse.”
The aforementioned statements suggest the “Four Balance Sheet” problem of banks, infrastructure firms, NBFCs, and real estate companies. In such an environment, it is found that banks have become risk averse leading to higher interest rates, and thus stymied investments and depressed growth. This is what India faced as 2020 began, as is exemplified in the numerous attempts to ensure liquidity to banks and NBFCs, and multiple interest rate cuts. Now, as COVID-19 and the consequent 21-day lockdown threaten(s) to completely derail the economy, the RBI and the Government have an immensely important burden to shoulder: to ensure the survival of an already ailing economy newly afflicted with the woes of the pandemic. Firstly, in the face of this behemoth task of not allowing the economy to collapse, RBI came out guns blazing. The Governor, Sh. Shaktikanta Das, and the Monetary Policy Committee (MPC) up till now had kept inflation its primary (and sometimes sole) target, and had refused to reduce interest rates substantially, contrary to the public sentiment. Now, in one single swoop on the 27th of March, after the expedited MPC meeting, RBI cut the Repo Rate (the rate at which banks can borrow short term funds from the RBI) by 75 basis points to 4.4%. Further, the Reverse Repo Rate (the rate at which banks can park their surplus funds with the RBI) was cut by 90 basis points to 4%. Overall, this incentivizes the commercial banks to park fewer funds with and borrow more from RBI, and thus increases their lending in the economy by large. Moreover, to increase liquidity, a host of other measures were taken. The Cash Reserve Ratio (the average percentage of total deposits that a bank must keep with itself as cash over a fortnight) was brought down a whole percent point: from 4% to 3%. This would allow an estimated ₹1.37 lakh crore to flow out as lending because fewer reserves are parked with banks. Also, the daily requirement of banks to maintain at least 90% of the earlier 4% CRR was brought down to 80%. Along with these initiatives, the RBI commenced the TLTRO (Targeted Long Term Repo Operations), which, basically, allows banks to borrow money from the RBI at the overnight rate (4.4%) but for periods of up to 3 years, thus incentivizing borrowing, again. The only caveat here is that these funds can only be used to invest in corporate bonds, which ensures that the benefit of the operation is passed on to the economy. Finally, a 3 month EMI Moratorium was also announced for all term loans of commercial banks, all India financial institutions, and NBFCs (outstanding as on 1 March 2020). This means individuals/organizations get to defer their EMI payments for 3 months with no risk to their credit rating, but the interest accrues, regardless. The decisions of the RBI were welcomed by experts amidst calls of more extreme steps should the disease continue into the second quarter. Yet, the spectre of doubt rises. What if these steps lead to inflation while supply does not pick up as is intended? “Stagflation” is, after all, a dangerous precedent. Despite this, these steps seemed inevitable from the perspective of a central bank. It is a war situation, and a fierce defence is required.
The government, two days after the declaration of the lockdown, announced a stimulus package of ₹1.7 lakh crore to help the poor tide over the crisis. With this, the government aims to distribute 5 kilograms of wheat or rice to each person free of cost, and one kilogram of pulses for every low-income family. It is estimated that this shall feed about 800 million poor people over the next three months. It also intends to hand out free cooking-gas cylinders to 83 million poor families; a one-time cash transfer of ₹1000 to 30 million senior citizens; as well as ₹500 a month to about 200 million poor women for next three months. This is speculated to drive the fiscal deficit to 6.2% this year. Though this pales relative to spending worldwide, it is, nonetheless, a much needed and commendable effort on the part of the government. It remains to be seen whether or not the combined efforts of the RBI (to restart the economy using cheap credit) and the Government (to fend for the poor and underprivileged of the nation) will be successful in helping the nation and the economy survive the pandemic. As these manoeuvres work (or fail), it is imperative to examine alternative theories and models.
On the Plea of Universal Basic Income, and Modern Monetary Theory More than half of the world’s population has been quarantined by their respective governments, and people seem tormented with the vintage misery of losing their jobs and lives over some disease. The question looms large: how is a man supposed to earn his living? Some propound that the answer is a Universal Basic Income (UBI). As the name suggests, UBI is a guaranteed income that is unconditional and available universally as a right. In recent times, specifically, the debate over it has skyrocketed. Governments all over the world are debating transferring of funds directly to their citizens to allow them to meet financial obligations and to prevent a complete demand-side collapse. Around three days ago, there were reports of Spain’s mulling over this proposal. The fact that these temporary measures are gaining widespread recognition seems to augur a permanent change in the public’s perception towards the UBI.
Google Keyword Search: Universal Basic Income The idea, by all means, is not new. It first appeared in Thomas Mores’ Utopia’ in 1516, and, since then, has lived in the fringes of economic thought, occasionally taken up by giants such as J.S. Mill, Henry George, Bertrand Russell, and F.A. Hayek. Historically though, UBI was meant to fight poverty and thievery. Thomas More wrote, “No penalty on earth will stop people from stealing, if it is their only way of getting food. It would be far more to the point to provide everyone with some means of livelihood”. While this reads like neo-utopian reverse-conditioning, the focus is on battling the inevitable loss of jobs due to automation. Elon Musk argues, "There will be fewer and fewer jobs that a robot cannot do better… and with this automation there will be abundance. Almost everything will get very cheap, and that money could theoretically be redistributed to give people financial security even if they don’t work”. Now, with COVID-19, the emphasis has shifted to surviving pandemics.
Further, the curious case of the UBI concerns itself with the ethical dilemmas of moral luck. In causal responsibility, an individual is one link in the chain of events (for example, an external factor interfered in the schemata which led to a mishap, and therefore, blame cannot be directly assigned to the individual). Moral responsibility ascribes positive/negative valence judgment to the individual. Exempli gratia, a billionaire: does it, indeed, bode well to severely tax the rich for the simple reason that they were born in the circumstances that permit them to survive, comfortably? Or, does it bode better to severely tax the enterprising individuals who profit off the gap between sales in first-world countries and the below-minimum wage paid to third-world agents? Certainly, the latter, if we must. However, there are a host of other variables involved, and models of prediction do not, often, have enough data to emulate the behaviour of such actors. Be that as it may, UBI has a few glaring issues that ought to be elaborated on:
1. Cost & Subsequent Taxing Money, we’re afraid, does not come from thin air. UBI will cost an exorbitant amount which will have to be taken care of by raising the taxes. And, when payment for the policy happens by increasing taxes on households rather than paying with debt, the policy is not truly expansionary. In actuality, it is giving to households with one hand what it is taking away with the other (red-tinged debates over billionaires and those who hoard taxes are for another day). There is no net effect. It must be noted here that despite the net theoretical effect being zero, there is still redistribution from the haves to the have-nots through taxation, and this, ideally, could spur consumption. 2. Inflation If the money isn’t taxed away and the government runs huge deficits to finance the UBI over a span of time, inflation (or hyperinflation) could be the theoretical end result. With an ever growing demand-side, supply could eventually fall short, and beyond a point inflation would become inevitable. 3. Incentive Structure With the UBI in place, there is a risk of the labour opting out of the labour market and thus pushing up wages, and unless Musk’s prophesied automation doesn’t come up, it would lead to the economic machine losing its fuel with fewer workers, and higher costs. This is where the Modern Monetary Theory (MMT) comes in. The heterodox theory, developed by Warren Mosler, had been cast to the undergrounds of Economics, and it too, with the current pandemic, has come in the spotlight with its Democrat socialist proponents such as Bernie Sanders, Alexandria Ocasio Cortez, and Elizabeth Warren. The MMT's main tenets are that a government which issues its own fiat money:
• can pay for goods, services, and financial assets without the inherent need to collect money in the form of taxes or debt issuance in advance of such purchases (modern money after all is just numbers on a screen); • cannot be forced to default on debt denominated in its own currency; • is only limited in its money creation and purchases by inflation, which accelerates once the real resources (labour, capital and natural resources) of the economy are utilized at full employment; • can control demand-pull inflation by taxation and bond issuance, which removes excess money from circulation (although, the political will to do so may not always exist); • need not compete with the private sector for scarce savings by issuing bonds. The first four points do not necessarily deviate from mainstream economic thought, and can be understood quite intuitively. The problem arises with the fifth point that negates “crowding out”.
Crowding out, the popular economic concept, states that when the government runs a budget deficit to push demand with increased government expenditure, it competes for funds in the loanable funds market with private investors. This competition then drives up the interest rate, reducing private investment and thus “crowding out” the funds with no real impact on the demand. Thus budget deficits are to be associated with rising interest rates. For MMT theorists, this is all but a myth. They say that the central bank sets the risk free overnight interest rate in the market and to defend its interest rate target, it manages overall system wide cash balances through open market operations. Governments, on their part, credit money as they spend, and debit it as they tax. If a government runs a budget deficit, it credits (net) money to the banks’ accounts (by spending) and thus increases their reserves. These excess reserves become a surplus in the overall banking system. Individual banks might have surpluses or deficits which they try to eliminate with horizontal transactions between themselves. These transactions, obviously, can never amount to zero. Thus, competition within the banks to lend out the excess reserves subsequently exerts downward pressure on the interest rate. And with this, the central bank has to intervene to defend the interest rate. The only option with the central bank now is
to issue government debt worth exactly the same amount as the deficit to ease this downward pressure and maintain its target. Ultimately, the private parties may refuse to hold further stocks of bonds and thus with no debt issuance, the interest rate will be brought down to zero. Further, with no way to dispense with the unwanted excess reserves but with increased consumption, there will be an expansion of demand. Whether it is inflationary or not depends on the supply side’s ability to cope with the rising demand. It is not dependent on the deficit itself. This results in the MMT suggestion of having perennial zero interest rate, justified by examples such as of Japan which has sustained near zero interest rates while running huge budget deficits. Thus, the focus shifts from the now futile monetary policy. The conclusion, ultimately, is that fiscal policy pushed by spending can be used to propel the economy towards full employment at no cost of inflation until full employment is reached and with no “crowding out”. And even then, taxation and issuance of bonds can control the demand-side led inflation. This conclusion is, increasingly, being used to justify the case of UBI and the humongous stimulus packages in a world whence debt to GDP ratios already are very high. The wisdom of this proposition, and of both the UBI and MMT is, individually, is left to the reader to ponder upon in quarantine.
money printer go brrrr
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