To give a background, direct monetization of deficit refers to a scenario where a central bank prints currency to the tune of accommodating massive deficit spending by the government. RBI does so by purchasing government securities directly in the primary market. Such a monetization process used to be automatic only until 1997, when it was later decided to end this practice by entrusting RBI to conduct such OMOs (Open Market Operations) only in the secondary market. However, an escape clause in the 2017 amendment of the FRBM (Fiscal Responsibility and Budget Management Act) act permits such direct monetisation under special circumstances.

What caught everybody’s eye was Viral Acharya’s warning against this act of deficit financing. According to the former deputy governor, adopting this approach is also deeply flawed as he expressed fears on inflation and Balance of Payments crisis. This has further ignited this macroeconomic debate. Well, those who nod in agreement to adopt the direct monetization route, follow from the idea of Modern Monetary Theory (MMT).

What is MMT and why does it warrant direct monetization of debt to finance higher fiscal spending? MMT is a heterodox economic school of thought introduced by the likes of Randall Wray, Bill Mitchell and Stephanie Kelton. The theory posits that monetarily sovereign countries, that issue debt and tax in their own sovereign currency, can afford to run large fiscal deficits by printing as much money as is needed to finance them. This spur of government spending however could cause inflation if there exist ‘real resources constraints’ of capital, labour, skills and technology.

Moreover, MMT argues that the government should spend ‘today’ and tax ‘tomorrow’ to drain out excess money from the economy, so that excess aggregate demand pressures can be stopped from imparting inflation. But, are we sure the inflation ‘tomorrow’ would be demand driven because the argument holds weight only when inflation ‘tomorrow’ is a result of an increased demand? Also, has Indian phenomenon been of the government taxing more after a period of spending spree? Or has it been more of a hawkish monetary policy stance? This demands an exploration in the present uncertain times. Also, the MMT asserts that a universal job guarantee programme in future can help ‘anchor’ inflation through fixing of a low fixed wage, but in India, where nearly 80% of labour force forms part of the unorganized sector, the hypothesis becomes weak. This is so because a large unorganized sector prevents wage signals to pass through the market.

In words of Prof Kelton, the leading authority on MMT, if there exists enough ‘slack’ i.e. underutilized resources and opportunities in the economy (as is the case in point for a labour abundant India), then printing money won’t stoke inflation. Rather, productivity would increase with the resultant increase in money supply. So, before India sets its foot in the MMT territory, the government should develop ‘credibility’ of its fiscal spends.

India can reap these productivity gains if there is ‘trust’ in the institutions to make productive spending decisions with higher growth multiplier effects. Such would be the call to not just step up capital expenditure on creation of an enabling infrastructure like roads, bridges, schools, hospitals, railway lines, airports and affordable housing, but also chart out a time bound plan of their execution.

As covid has rung loud alarms about the weaknesses in the economy, the government will need to work on multiple dimensions. It could start by bringing transparency in fiscal spends by depicting off-budget borrowings in the fiscal deficit, and secondly, by adopting a ‘credible medium term’ fiscal framework that relies on improving revenue mobilization. Needless to mention, a medium term fiscal framework has been long argued for by Prof. Rathin Roy, director at the NIPFP. Thirdly and most importantly, fiscal policy of this transformed world will need to tackle grave issues of inequality by enhancing universal access to healthcare and education and progressive tax systems, as argued in an IMF blog by Vitor Gaspar and Gita Gopinath.

This fiscal plan would require a body like CAG (Comptroller and Auditor General of India) to assume a greater role in checking the credibility of fiscal expenditures so as to carefully navigate the government in its path to fiscal consolidation. To sum up, India’s growth story needs to be driven by inclusivity and high productivity to start with and then probably, printing money could do less harm than good. However, until India is ripe for MMT to play out, debates should continue to brew.

(Nitya Chutani is assistant professor, Department of Economics, Sri Guru Gobind Singh College of Commerce, University of Delhi. Views are personal and do not reflect Mint’s)