A Modigliani-Miller Theorem for the Public Finances of Globalized Economies: Theory, Policy Implications, and Keynesian Reflections

This article is about the economics of the power of global finance to enforce its own interests over national economies. In line with the capital structure irrelevance principle of Modigliani and Miller (1958) as applied to corporate finance, the article shows that the value of the public sector claims (money and debt) of a financially globalized economy is independent of the capital structure of the government’s finances. In particular, the article transposes the Modigliani-Miller approach (enhanced as needed) to public finances and proves a new "neutrality theorem" (and two important related corollaries) whereby, in an economy that is internationally highly financially integrated, the cost of the capital needed by governments to finance their deficits is independent of whether: i) financing originates from debt or money, ii) debt is denominated in domestic or foreign currency, and iii) money and debt are issued under floating or fixed exchange rates. The two corollaries show that governments seeking to monetize their deficits must remunerate money holdings with a return that vary inversely with credibility is lower and directly with the stock of money (eventually defying the original policy objective). The article discusses the options available for countries to approach financial globalization.