Tag Archives: #ModernMonetaryTheory

SOFT CURRENCY ECONOMICS. MMT, The Final Analysis – Warren Mosler.

Modern Monetary Theory, MMT, in a Nutshell – Johnsville * MMT, a quick start guide * Modern Money Theory: Deadly Innocent Fraud #1. Government Must Tax To Spend. – Warren Mosler.

“It is the neoclassical orthodoxy and others who try to make out that we can’t use resources, even if they are available, because of some magical, mysterious monetary or financial constraint. Just who is it that believes in magic here?

Operationally, federal spending is not revenue constrained. All constraints are necessarily self imposed and political. And everyone in Fed operations knows it.

The foundation of MMT is its recognition of the importance of the government’s power to tax, thereby creating a demand for its money, and its monopoly power to print money.

MMT’s full potential and its massive monetary fire power were not locked and loaded until President Nixon took the U.S. off the gold standard on August 15, 1971.”

A rampaging mutant macroeconomic theory called Modern Monetary Theory, or MMT for short, is kicking keisters and smacking down conventional wisdom in economic circles these days. This is because an energized group of MMT economists, bloggers, and their loyal foot soldiers, lead by economists Warren Mosler, Bill Michell, and L. Randall Wray are swarming on the internet.

New MMT disciples are hatching out everywhere. They are like a school of fresh-faced paramedics surrounding a gasping heart attack victim. They seek to present their economic worldview as the definitive first aid for understanding and dealing with the critical issues of growth, unemployment, inflation, budget deficits, and national debt.

MMT is a reformulated blend of some older macroeconomic theories called Chartalism and Functional finance. But, it also adds a fresh dose of monetary accounting for intellectual muscle mass. Chartalism is a school of economic thought that was developed between 1901 and 1905 by German economist Georg F. Knapp with important contributions (1913-1914) from Alfred Mitchell-Innes. Functional finance is an extension of Chartalism, which was developed by economist Abba Lerner in the 1940’s.

However, Chartalism and Functional finance did not directly spawn this new mutant monetary theory. Rather, Modern Monetary Theory had a hot, steamy, Rummy induced, immaculate conception as its creator, Warren Mosler, has stated:

“The origin of MMT is ‘Soft Currency Economics‘ [1993] at http://www.moslereconomics.com which I wrote after spending an hour in the steam room with Don Rumsfeld at the Racquet Club in Chicago, who sent me to Art LajTer, who assigned Mark McNary to work with me to write it. The story is in ‘The 7 Deadly Innocent Frauds of Economic Policy’ [pg 98].

I had never read or even heard of Lerner, Knapp, Inness, Chartalism, and only knew Keynes by reading his quotes published by others. I ‘created’ what became know as ‘MMT’ entirely independently of prior economic thought. It came from my direct experience in actual monetary operations, much of which is also described in the book.

The main takeaways are simply that with the $US and our current monetary arrangements, federal taxes function to regulate demand, and federal borrowing functions to support interest rates, with neither functioning to raise revenue per se. In other words, operationally, federal spending is not revenue constrained. All constraints are necessarily self imposed and political. And everyone in Fed operations knows it.”

The name Modern Monetary Theory was reportedly coined (pun unintended) by Australian economist Bill Mitchell. Mitchell has an MMT blog that gives tough weekly tests in order to make sure that the faithful are paying attention and learning their MMT ABC’s. MMT is not easy to fully comprehend unless you spend some time studying it.

MMT is a broad combination of fiscal, monetary and accounting principles that describe an economy with a floating rate fiat currency administered by a sovereign government.

The foundation of MMT is its recognition of the importance of the government’s power to tax, thereby creating a demand for its money, and its monopoly power to print money.

MMT’s full potential and its massive monetary fire power were not locked and loaded until President Nixon took the U.S. off the gold standard on August 15, 1971.

There is really not that much “theory” in Modern Monetary Theory. MMT is more concerned with explaining the operational realities of modern fiat money. It is the financial X’s and 0’s, the ledger or playbook, of how a sovereign government’s fiscal policies and financial relationships drive an economy. It clarifies the options and outcomes that policy makers face when they are running a tax-driven money monopoly.

Proponents of MMT say that its greatest strength is that it is apolitical.

The lifeblood of MMT doctrine is a government’s fiscal policy (taxing and spending). Taxes are only needed to regulate consumer demand and control inflation, not for revenue. A sovereign government that issues its own floating rate fiat currency is not revenue constrained. In other words, taxes are not needed to fund the government. This point is graphically described by Warren Mosler as follows:

“What happens if you were to go to your local IRS office to pay your taxes with actual cash? First, you would hand over your pile of currency to the person on duty as payment. Next, he’d count it, give you a receipt and, hopefully, a thank you for helping to pay for social security, interest on the national debt, and the Iraq war. Then, after you, the tax payer, left the room he’d take that hard-earned cash you just forked over and throw it in a shredder.

Yes, it gets thrown away [sic]. Destroyed!”

The 7 Deadly Frauds of Economic Policy, page 14, Warren Mosler

Gadzooks!

The delinking of tax revenue from the budget is a critical element that allows MMT to go off the “balanced budget” reservation.

In a fiat money world, a sovereign government’s budget should never be confused with a household budget, or a state budget. Households and U.S. states must live within their means and their budgets must ultimately be balanced. A sovereign government with its own fiat money can never go broke. There is no solvency risk and the United States, for example, will never run out of money.

The monopoly power to print money makes all the difference, as long as it is used wisely.

MMT also asserts that the federal government should net spend, again usually in deficit, to the point where it meets the aggregate savings desire of its population. This is because government budget deficits add to savings. This is a straightforward accounting identity in MMT, not a theory. Warren Mosler put it this way:

“So here’s how it really works, and it could not be simpler: Any $U.S. government deficit exactly EQUALS the total net increase in the holdings ($U.S. financial assets) of the rest of us businesses and households, residents and non-residents what is called the “non-government” sector. In other words, government deficits equal increased “monetary savings” for the rest of us, to the penny. Simply put, government deficits ADD to our savings (to the penny).”

The 7 Deadly Frauds of Economic Policy, page 42, Warren Mosler

Therefore, Treasury bonds, bills and notes are not needed to support fiscal policy (pay for government). The U.S. government bond market is just a relic of the pre-1971 gold standard days. Treasury securities are primarily used by the Fed to regulate interest rates. Mosler simply calls U.S. Treasury securities a “savings account” at the Federal Reserve.

In the U.S., MMTers see the contentious issue of a mounting national debt and continuing budget deficits as a pseudo-problem, or an “accounting mirage.” The quaint notion of the need for a balanced budget is another ancient relic from the old gold standard days, when the supply of money was actually limited. In fact, under MMT, running a federal budget surplus is usually a bad thing and will often lead to a recession.

Under MMT the real problems for a government to address are ensuring growth, reducing unemployment, and controlling inflation. Bill Mitchell noted that, “Full employment and price stability is at the heart of MMT.” A Job Guarantee (JG) model, which is central to MMT, is a key policy tool to help control both inflation and unemployment. Therefore, given the right level of government spending and taxes, combined with a Job Guarantee program; MMTers state emphatically that a nation can achieve full employment along with price stability.

As some background to understand Modern Monetary Theory it is helpful to know a little about its predecessors: Chartalism and Functional Finance.

German economist and statistician Georg Friedrich Knapp published The State Theory of Money in 1905. It was translated into English in 1924. He proposed that we think of money as tokens of the state, and wrote:

“Money is a creature of law. A theory of money must therefore deal with legal history… Perhaps the Latin word “Charta” can bear the sense of ticket or token, and we can form a new but intelligible adjective “Chartal.” Our means of payment have this token, or Chartalform. Among civilized peoples in our day, payments can only be made with pay-tickets or Chartal pieces.”

Alfred Mitchell-Innes only published two articles in the The Banking Law journal. However, MMT economist L. Randall Wray called them the ”best pair of articles on the nature of money written in the twentieth century”. The first, What is Money?, was published in May 1913, and the follow-up, Credit Theory of Money, in December 1914. Mitchell-Innes was published eight years after Knapp’s book, but there is no indication that he was familiar with the German’s work. In the 1913 article Mitchell-Innes wrote:

“One of the popular fallacies in connection with commerce is that in modern days a money-saving device has been introduced called credit and that, before this device was known, all, purchases were paid for in cash, in other words in coins. A careful investigation shows that the precise reverse is true…

Credit is the purchasing power so often mentioned in economic works as being one of the principal attributes of money, and, as I shall try to show, credit and credit alone is money. Credit and not gold or silver is the one property which all men seek, the acquisition of which is the aim and object of all commerce…

There is no question but that credit is far older than cash.”

L. Randall Wray, in his 1998 book, Understanding Modern Money, was the first to link the state money approach of Knapp with the credit money approach of Mitchell-Innes. Modern money is a state token that represents a debt or IOU. The book is an introduction to MMT.

Finally, to finish the historical tour, here is how Abba Lerner’s Functional finance is described by professor Wray:

“Functional Finance rejects completely the traditional doctrines of ‘sound finance’ and the principle of trying to balance the budget over a solar year or any other arbitrary period. In their place it prescribes: first, the adjustment of total spending (by everybody in the economy, including the government) in order to eliminate both unemployment and inflation, using government spending when total spending is too low and taxation when total spending is too high.”

Given its mixed history it is not surprising that MMT has been given different labels. Some economists refer to MMT as a “post-Keynesian” economic theory. L. Randall Wray has used the term “neo-Chartalist”. Warren Mosler stated, “MMT might be more accurately called pre-Keynesian.” Given that Georg Knapp’s work was cited by John Maynard Keynes, the use of “pre-Keynesian” does seem more appropriate than “post-Keynesian”.

But under any category, MMT has been considered fringe or heterodox economics by most mainstream economists. It therefore has been relegated to the equivalent of the economic minor leagues, somewhere below triple-A level. However, that perception is changing.

MMT is slowly seeping into the public policy debate. These days Warren Mosler and others with an MMT viewpoint are frequently being interviewed on business news channels. MMT articles are being published. Recently, Steve Liesman, CNBC’s senior economics reporter, used a Warren Mosler quote to make a point. Liesman said: “As Warren Mosler has said: ‘Because we think we may be the next Greece, we are turning ourselves into the next Japan .

MMT is not easy for many people, including trained economists, to understand. This is probably because of its heavy reliance on accounting principles (debts and credits). Some critics consider MMT nothing more than a twisted Ponzi scheme that is simply “printing prosperity.” Calling MMT a “printing prosperity” scheme, by the way, is the quickest way to send MMTers into spasms of outrage. MMT does not “print prosperty” according to its proponents. The MMT counter argument is:

“It is a perverse injustice that, in online discussions, MMT sympathizers are frequently reproached for imagining that “we can print prosperity” when in fact it is us who constantly stress as a fundamental point that the only true constraints are resource based, not financial or monetary in nature. We are the ones insisting that if we have the resources, we can put them to use. It is the neoclassical orthodoxy and others who try to make out that we can’t use resources, even if they are available, because of some magical, mysterious monetary or financial constraint. Just who is it that believes in magic here?”

Emotions run hot in the current economic environment, especially on the internet. In some cases the energetic online promoting of MMT has turned into passive aggressive hectoring, hazing, name calling, badgering, and belittling. So be warned, if you write some economic analysis online that disagrees with MMT doctrine you might find yourself attacked and stung by a swarm of MMTers. If you are an economic “expert” and you do not understand monetary basics you may also get mounted on an MMT wall of shame.

A heavyweight Keynesian economist, like Nobel Prize winner Paul Krugman, has felt the sting of MMT. But the quantity and quality of his criticism of MMT, so far, has been featherweight. He could not land a solid glove on the contender, Kid MMT. Krugman only proved that he does not understand MMT, so his criticism was weak (see MMT comments) and his follow-up even weaker. MMT economist James Galbraith did a succinct breakdown of Krugman’s major errors.

Another school of economics feeling the heat from MMT are the Austrians. Austrian economist Robert Murphy recently wrote an article critical of MMT, calling it an “Upside Down World”. MMTers lined up to disassemble and refute Murphy’s essay. Cullen Roach at the Pragmatic Capitalist blog shot back this broadside:

“We now live in a purely fiat world and not the gold standard model in which Mises and many of the great Austrian economists generated their finest work. Therein lies the weakness of the Austrian model. It is based on a monetary system that is no longer applicable to modern fiat monetary systems such as the one that the USA exists in.”

Does MMT really offer a path to prosperty? Or did the ancient Roman, Marcus Cicero (106BC-43BC), have it right when he said: “Endless money forms the sinews of war.”? The debate will only intensify. If you value those green, money-thing, government IOU tokens in your wallet then it pays to learn what all the commotion is about.

MMT, a quick start guide

Because of MMT’s growing popularity it might be helpful to present a quick start guide so beginners can get up to speed and understand some of its fundamental elements. As a starting point here are some basics of Modern Monetary Theory (MMT) compared to some other principles of money and economics that might be considered conventional wisdom or old school wisdom.

1. What is money?

Modern Monetary Theory: Money is a debt or IOU of the state.

“The history of money makes several important points. First, the monetary system did not start with some commodities used as media of exchange, evolving progressively toward precious metals, coins, paper money, and finally credits on books and computers. Credit came first and coins, late comers in the list of monetary instruments, are never pure assets but are always debt instruments IOUs that happen to be stamped on metal...

Monetary instruments are never commodities, rather they are always debts, IOUs, denominated in the socially recognized unit of account. Some of these monetary instruments circulate as “money things” among third parties, but even “money things” are always debts whether they happen to take a physical form such as a gold coin or green paper note.”

Money: An Alternate Story by Eric Lymoigne and L. Randall Wray

“Money is a creature of law”, and, because the state is “guardian of the law”, money is a creature of the state. As Keynes stated:

“The Age of Chartalist or State Money was reached when the State claimed the right to declare what thing should answer as money to the current money-of-account… (Keynes 1930)…”

Chartalism, Stage of Banking, and Liquidity Preference by Eric Tymoigne

John Maynard Keynes in his 1930 Treatise on Money, also stated: “Today all civilized money is, beyond the possibility of dispute, Chartalist.”

Old School Wisdom:

“Money is essentially a device for carrying on business transactions, a mere satellite of commodities, a servant of the processes in the world of goods.”

Joseph Schumpeter, Schumpeter on money, banking and finance… by A. Festre and E. Nasica

Conventional Wisdom:

“Money is any object or record, that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context.”

Wikipedia


2. Why is money needed?

MMT: Money is needed in order to pay taxes.

“Money is created by government spending (or by bank loans, which create deposits). Taxes serve to make us want that money we need it in order to pay taxes.”

The 7 Deadly Frauds of Economic Policy, Warren Mosler

“The inordinate focus of other economists on coins (and especially on government issued coins), market exchange and precious metals, then appears to be misplaced.

The key is debt, and specifically, the ability of the state to impose a tax debt on its subjects; once it has done this, it can choose the form in which subjects can ‘pay’ the tax. While governments could in theory require payment in the form of all the goods and services it requires, this would be quite cumbersome. Thus it becomes instead a debtor to obtain what it requires, and issues a token (hazelwood tally or coin) to indicated the amount of its indebtedness; it then accepts its own token in payment to retire tax liabilities.

Certainly its tokens can also be used as a medium of exchange (and means of debt settlement among private individuals), but this derives from its ability to impose taxes and its willingness to accept its tokens, and indeed is necessitated by imposition of the tax (if one has a tax liability but is not a creditor of the Crown, one must offer things for sale to obtain the Crown’s tokens).”

Money: An Alternate Story by Eric Iymoigne and L. Randall Wray

“Money, in the Chartalist view, derives from obligations (fines, fees, tribute, taxes) imposed by authority; this authority then “spends” by issuing physical representations of its own debts (tallies, notes) demanded by those who are obligated to pay “taxes” to the authority. Once one is indebted to the crown, one must obtain the means of payment accepted by the crown. One can go directly to the crown, offering goods or services to obtain the crown’s tallies, or one can turn to others who have obtained the crown’s tallies, by engaging in “market activity” or by becoming indebted to them. Indeed, “market activity” follows (and follows from) imposition of obligations to pay fees, fines, and taxes in money form.”

A Chartalist Critique of john Locke’s Theory of Property, Accumulation and Money… by Bell, Henry, and Wray

Conventional Wisdom:

Money is needed as a medium of exchange, a unit of account, and a store of value.

Old School Wisdom:

Money is needed because it could “excite the industry of mankind. ”

Thomas Hume, Hume, Money and Civilization… by C. George CajTettzis

Old School Tony Montoya, aka Scarface, Wisdom: money is needed for doing business, settling debts, and emergency situations…

Hector the Toad: So, you got the money? Tony Montana: Yep. You got the stuff? Hector the Toad: Sure I have the stuff. I don’t have it with me here right now. I have it close by.

Tony Montana: Oh… well I don’t have the money either. I have it close by too.

Hector the Toad: Where? Down in your car?

Tony Montana: [lying] Uh… no. Not in the car.

Hector the Toad: No?

Tony Montana: What about you? Where do you keep your stuff‘?

Hector the Toad: Not far.

Tony Montana: I ain’t getting the money unless I see the stuff first.

Hector the Toad: No, no. First the money, then the stuff.

Tony Montana: [after a long tense pause] Okay. You want me to come in, and we start over again?

Hector the Toad: [changing the subject] Where are you from, Tony?

Tony Montana: [getting angry and supicious] What the f **k difference does that make on where I ’m from?

Hector the Toad: Cona, Tony. I ’m just asking just so I know who I ’m doing business with.

Tony Montana: Well, you can know about me when you stop f **king around and start doing business with me, Hector! […]

Hector the Toad: You want to give me the cash, or do I kill your brother first, before I kill you?

Tony Montana: Why don’t you try sticking your head up your ass? See if it fits. […J

Frank Lopez: [pleading] Please Tony, don’t kill me. Please, give me one more chance. I give you $10 million. $10 million! All of it, you can have the whole $10 million. I give you $10 million. I give you all $10 million just to let me go. Come on, Tony, $10 million. It’s in a vault in Spain, we get on a plane and it’s all yours. That’s $10 million just to spare me.

Dialog from Scarface, the movie.

Note: The comment about the $10 million stashed in a Spanish vault highlights a small chink in MMT’s armor. If the taxing power of the sovereign state is sabotaged, or there is widespread tax evasion, then MMT falls apart.


3. Where does money come from?

MMT: The government just credits accounts.

Modern money comes from “nowhere.” Bill Mitchell

Conventional Wisdom: Money comes from the government printing currency and making it legal tender.


4. Government Spending: any limits?

MMT: government spending is not constrained.

“A sovereign government can always spend what it wants. The japanese government, with the highest debt ratio by far (190 per cent or so) has exactly the same capacity to spend as the Australian government which has a public debt ratio around 18 per cent (last time I looked). Both have an unlimited financial capacity to spend.

That is not the same thing as saying they should spend in an unlimited fashion. Clearly they should run deficits sufficiently to close the non-government spending gap. That should be the only fiscal rule they obey.” Bill Mitchell

Conventional Wisdom: government spending should be constrained.

“One option to ensure that we begin to get our fiscal house in order is a balanced budget amendment to the Constitution. I have no doubt that my Republican colleagues will overwhelmingly support this common sense measure and I urge Democrats to as well in order to get our fiscal house in order.”

House Majority Leader Eric Cantor (RVA), June 23th, 2010

5. What is Quantitative Easing?

MMT: It is an asset swap. It is not “printing money” and it is not a very good anti-recession strategy.

“Quantitative easing merely involves the central bank buying bonds (or other bank assets) in exchange for deposits made by the central bank in the commercial banking system that is, crediting their reserve accounts… So quantitative easing is really just an accounting adjustment in the various accounts to reflect the asset exchange. The commercial banks get a new deposit (central bank funds) and they reduce their holdings of the asset they sell…

Invoking the “evil-sounding” printing money terminology to describe this practice is thus very misleading and probably deliberately so.

All transactions between the Government sector (Treasury and Central Bank) and the non-government sector involve the creation and destruction of net financial assets denominated in the currency of issue. Typically, when the Government buys something from the non-government sector they just credit a bank account somewhere that is, numbers denoting the size of the transaction appear electronically in the banking system.

It is inappropriate to call this process “printing money”. Commentators who use this nomenclature do so because they know it sounds bad! The orthodox (neoliberal) economics approach uses the “printing money” term as equivalent to “inflationary expansion”. If they understood how the modern monetary system actually worked they would never be so crass…

So I don’t think quantitative easing is a sensible anti-recession strategy. The fact that governments are using it now just reflects the Neoliberal bias towards monetary policy over fiscal policy…” Bill Mitchell

Conventional Wisdom: Quantitative Easing is “money printing”

James Grant, editor of Grant’s Interest Rate Observer, says Quantitative Easing is just Money Printing.


6. What is the view on personal debt?

MMT: personal debt is not dangerous.

“Americans today have too much personal debt. False. Private debt adds money to our economy. Though bankruptcies have increased lately, that is due more to the liberalization of bankruptcy laws, rather than to economics. Despite rising debt and bankruptcies, our economy has continued to grow. The evidence is that high private debt has had no negative effect on our economy as a whole, though it can be a problem for any individual.”

Free Money: Plan for Prosperity ©2005 (pg 154), by Rodger Malcolm Mitchell

.
Note: Rodger Mitchell is an MMT extremist. He calls his brand of MMT, “Monetary Sovereignty”. Not all of his views may be in sync with mainstream MMT doctrine.


Conventional Wisdom: too much debt is dangerous.

“The core of our economic problem is, instead, the debt, mainly mortgage debt that households ran up during the bubbleyears of the last decade. Now that the bubble has burst, that debt is acting as a persistent drag on the economy, preventing any real recovery in employment.” Paul Krugman

Old School Wisdom: debt is always dangerous.

“Neither a borrower, nor a lender be”

Polonius speaking in Hamlet, by William Shakespeare

7. What is the view on foreign trade?

MMT: Exporters please just take some more fiat money and everyone will be fat and happy!

“Think of all those cars japan sold to us for under $2,000 years ago. They’ve been holding those dollars in their savings accounts at the Fed (they own US. Treasury securities), and if they now would want to spend those dollars, they would probably have to pay in excess of $20,000 per car to buy cars from us. What can they do about the higher prices? Call the manager and complain? They’ve traded millions of perfectly good cars to us in exchange for credit balances on the Fed’s books that can buy only what we allow them to buy…

We are not dependent on China to buy our securities or in any way fund our spending. Here’s what’s really going on:

Domestic credit creation is funding foreign savings…

Assume you live in the US. and decide to buy a car made in China. You go to a US. bank, get accepted for a loan and spend the funds on the car. You exchanged the borrowed funds for the car, the Chinese car company has a deposit in the bank and the bank has a loan to you and a deposit belonging to the Chinese car company on their books. First, all parties are “happy.” You would rather have the car than the funds, or you would not have bought it, so you are happy. The Chinese car company would rather have the funds than the car, or they would not have sold it, so they are happy. The bank wants loans and deposits, or it wouldn’t have made the loan, so it’s happy.

There is no “imbalance.” Everyone is sitting fat and happy…”

Warren Mosler, The 7 Deadly Frauds of Economic Policy

Old School Wisdom: Trade arrangements will break down if a currency is debased.

“Sorry paleface, Chief say your wampum is no good. We want steel knives and firewater for our beaver pelts.” American Indian reaction after Dutch colonists debase wampum in the 1600’s


See also:

Modern Money Theory: Deadly Innocent Fraud #1. Government Must Tax To Spend. – Warren Mosler

MODERN MONETARY THEORY. Australian inflation data defies mainstream macro predictions, again – Bill Mitchell.

Even though inflation has been benign now for some quarters, the market economists, banks, still think it is about to accelerate and the RBA will be hiking interest rates.

But the reality is quite the opposite.

One of the on-going myths that mainstream (New Keynesian) economists propagate is that monetary policy (adjusting of interest rates) is an effective way to manage the economic cycle. They claim that central banks can effectively manipulate total spending by adjusting the cost of borrowing to increase output and push up the inflation rate. The empirical experience does not accord with those assertions.

Central bankers around the world have been demonstrating how weak monetary policy is in trying to stimulate demand. They have been massively building up their balance sheets through QE to push their inflation rates up without much success.

Further, it has been claimed that a sustained period of low interest rates would be inflationary. Well, again the empirical evidence doesn’t support that claim. The evidence supports the Modern Monetary Theory (MMT) preference for fiscal policy over monetary policy.

. . . Professor Bill Mitchell

Why should someone who is anti-austerity care about debt – Simon Wren-Lewis.

For a country that can create its own currency there is never any necessity to default.

Most of the posts I have written about austerity have been aimed at countering the idea that in a recession you need to bring down government deficits and therefore debt. But what if you accept all that (you are anti-austerity). Why should you care about debt at all? Why do we have fiscal rules based on deficits? Why not spend what the government needs to spend, and not worry that this resulted in a larger budget deficit?

The story often given is that the markets will impose some limit on what the government will be able to borrow, because if debt gets ‘too high’ in relation to GDP markets will start demanding a higher return. You can see why that argument is problematic by asking why interest rates on government debt would need to be higher. The most obvious reason is default risk. But for a country that can create its own currency there is never any necessity to default.

Being anti-austerity does not mean we can forget about debt completely, as long as we are using interest rates rather than fiscal policy to control demand.

. . . Mainly Macro

Modern Monetary Theory. IMF continues to tread the ridiculous path – Bill Mitchell.

Last week, the IMF released its so-called Fiscal Monitor October 2018.

Apparently the British government, which issues its own currency, has ‘shareholders’ who care about its Profit and Loss statement and the flow implications of the latter for the Balance Sheet of the Government.

Anyone who knows anything quickly realises this is a ruse. There is no meaningful application of the ‘finances’ pertaining to a private corporation to the ‘finances’ of a currency-issuing government.

A currency-issuing government’s ‘balance sheet’ provides no help in our understanding of what spending capacities such a government has.

A currency-issuing government can always service any liabilities that are denominated in its own currency.

. . . Professor Bill Mitchell’s blog

Why is MMT so popular? – Simon Wren-Lewis.

Although MMT has been around for some time, it recently held its first international conference and has in the last few years attracted a devoted band of followers online. According to an article in The Nation, it has ‘rock star appeal’.

There are short and simple explainers around, but what these and MMT followers are typically not so good at is in explaining exactly why and how they differ from mainstream macroeconomics.

To understand this, we need to go back to the 1960s and 70s. Then there was a debate between two groups in macro over whether it was better to use monetary policy or fiscal policy as an instrument for stabilising the economy. I prefer to call these two groups Monetarists and Fiscalists, because both sides used the same theoretical framework, which was Keynesian.

To cut a long story short the monetarist won that argument, although not quite in the way they intended. Instead of central banks controlling the economy in a hands off way using the money supply, they instead actively used interest rate changes to control output and inflation.

Fiscal policy was increasingly seen as about controlling the level of government debt. I have called this the Consensus Assignment, because it became a consensus and because I don’t think there is another name for it.

The one or two decades before the financial crisis were the golden years for the Consensus Assignment, in the sense that monetary policy did seem to be relatively successful at controlling inflation and dampening the business cycle. However many governments were less successful at controlling government debt, and this failure was termed ‘deficit bias’.

MMT is essentially different because it rejects the Consensus Assignment. It regards monetary policy as an unreliable instrument for controlling the economy, and MMT prefers to use fiscal policy instead. They are, to use my previous terminology, fiscalists.

If you are always using government spending or taxes to control the economy, you are right not to worry about the budget deficit: it is whatever it needs to be to get inflation to target. Whether you finance those deficits by creating money or selling bonds is also a secondary concern – it just influences what the interest rate is, which has an uncertain impact on activity. For this reason you do not need to worry about who will buy your debt, because you can create money instead.

The GFC exposed the Achilles Heel in the Consensus Assignment, because interest rates hit their lower bound and could no longer be moved to stimulate demand. Alternative measures like QE really were as unreliable as MMT thinks all monetary policy is. What governments started to do was use fiscal policy instead of monetary policy to support the economy, but then austerity happened in 2010.

Now we can see why MMT is so popular. Austerity is about governments pretending the Consensus Assignment still works when it does not, because interest rates are at their lower bound. We are in an MMT world, where we should be using fiscal policy and not worrying about the deficit, but policymakers don’t understand that. I think most mainstream macroeconomists do understand this, but we are not often heard. The ground was therefore ripe for MMT.

Policymakers following austerity when they clearly should not annoys me a great deal, and I am very happy to join common cause with MMT on this. By comparison, the things that annoy me about MMT are trivial, like a failure to use equations and their wordplay. You will hear from MMTers that taxes do not finance government spending, or that spending comes first, but you will hardly ever see the government’s budget constraint which makes all such semantics seem silly.

MMT is particularly attractive because it does away with the perennial ‘where is the money going to come from’ question. Instead it replaces this question with another: ‘will this extra spending raise inflation above target’. As long as inflation is below target that does not appear to be a constraint. In the US right now interest rates are no longer at their lower bound, but inflation is below target, so it appears to MMTers that the government should not worry about how extra spending is paid for.

Of course having a fiscal authority following MMT and a central bank following the Consensus Assignment once rates are above their lower bound could be a recipe for confusion, unless you believe what happens to interest rates is unimportant. I personally think we have strong econometric evidence that changes in interest rates do matter, so once we are off the lower bound should we be fiscalists like MMT or should we return to the Consensus Assignment? That is a question for another day.

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The Rock-Star Appeal of Modern Monetary Theory

The Sanders generation and a new economic idea.

by Atossa Araxia Abrahamian

In early 2013, Congress entered a death struggle, or a debt struggle, if you will, over the future of the US economy. A spate of old tax cuts and spending programs were due to expire almost simultaneously, and Congress couldn’t agree on a budget, nor on how much the government could borrow to keep its engines running. Cue the predictable partisan chaos: House Republicans were staunchly opposed to raising the debt ceiling without corresponding cuts to spending, and Democrats, while plenty weary of running up debt, too, wouldn’t sign on to the Republicans’ proposed austerity.

In the absence of political consensus, and with time running out, a curious solution bubbled up from the depths of the economic blogosphere. What if the Treasury minted a $1 trillion coin, deposited it in the government’s account at the Federal Reserve, and continued on with business as usual? The workaround was technically authorized by an obscure law that applies to commemorative platinum coins, and it didn’t require congressional approval, so the GOP couldn’t get in the way. What’s more, the cash would not be circulated, so it wouldn’t cause inflation.

The thought experiment was catnip for wonks and bloggers, who described it as “ludicrous but perfectly legal” (Slate); “a monetary parlor trick” (Wired); “really thrilling” (Business Insider); “a large-scale trolling project” (The Guardian). The idea made its way onto late-night TV, political talk shows, White House press conferences, and lived on as a hashtag: #mintthecoin.

At the heart of the attention was an acknowledgement that money wasn’t the problem here, politics was.

For a small but committed group of economists, academics, and activists who adhere to a doctrine called Modern Monetary Theory (MMT), though, #mintthecoin was the tip of the economic iceberg. The possibility of a $1 trillion coin represented more than mere monetary sophistry: It drove home their foundational point that fiat currency is a social construct, and that there are therefore no fiscal limits on how much a sovereign currency-issuing nation can spend.

According to this small but increasingly vocal cohort of economists, including Bernie Sanders’s former chief economic adviser, once we change the way we think about money, we can provide for everyone: We don’t have to “find” the money to “pay” for universal health care by “cutting” the budget elsewhere. In fact, our government already works that way: Spending must precede taxation, or there would be no dollars in the economy to tax. It’s the political will to spend on certain things, not the money to afford it, that’s lacking.

“The idea that you can’t feed hungry kids and build a bridge is a huge problem,” says Stephanie Kelton, an economist at the University of Missouri, Kansas City. “It’s cruel to say we want more money for education and food but have to wait for legislation.”

Kelton, who spoke about the coin on MSNBC, is MMT’s most mediagenic expert. She’s 48 years old, whip-smart, impeccably coiffed, and brims with enthusiasm, important for someone who spends half her time telling Wall Street types to rethink their basic approach to economics. When Sanders ran for the Democratic nomination, Kelton became his chief economic adviser at the recommendation of several prominent left-wing economists, including Dean Baker and Jamie Galbraith. Before that, she served as chief economist on the Senate Budget Committee and moonlighted as the editor of a blog called New Economic Perspectives.

Kelton sees the fundamentals of her work as “a descriptive analysis that could be exploited by either side: Democrats and Republicans can use the insight to push tax cuts or increase spending.” Indeed, the idea of a big-spending economic stimulus to fix the country’s infrastructure served as a common ground for Trump and Sanders voters who liked the idea of jobs perhaps more than they disliked the idea of national indebtedness. If that’s what voters want, then MMT is a rare bird: an economic theory that not only validates their hunches, but contends that they’re the key to a healthy, stable, prosperous economy for all.

Modern Monetary Theory emerged as a distinct school of economic thought in the 1990s, when Kelton and her colleagues, mainly professors with homes in heterodox economics departments like the University 6 Missouri, Kansas City, and Bard’s Levy Institute, published research and discussed their theories, albeit mainly among themselves on a now-defunct listserv called “Post-Keynesian Thought” and at an annual conference that started in 2003.

The various strains of thought that make up MMT have their roots in Adam Smith and John Maynard Keynes, along with more contemporary thinkers like Hyman Minsky and Abba Lerner, but only recently have researchers connected the dots in quite this way. “We’ve rediscovered old ideas,” Kelton said, “and assembled them into a complete macroeconomic frame.”

To a layperson, MMT can seem dizzyingly complex, but at its core is the belief that most of us have the economy backward.

Conventional wisdom holds that the government taxes individuals and companies in order to fund its own spending. But the government, which is ultimately the source of all dollars, taxed or untaxed, pays or spends first and taxes later. When it funds programs, it literally spends money into existence, injecting cash into the economy. Taxes exist in order to control inflation by reducing the money supply, and to ensure that dollars, as the only currency accepted for tax payments, remain in demand.

It follows that currency-issuing governments could (and, depending on how you lean politically, should) spend as much as they need to in order to guarantee full employment and other social goods. MMT’s adherents like to point out that the federal government never “runs out” of money to fund the military, but routinely invokes budget constraints to justify defunding social programs. Money, in other words, isn’t a scarce commodity like silver or gold. “To people who’ve worked in financial markets, who work at the Fed, this isn’t controversial at all,” says Galbraith, who, while not an adherent, can certainly be described as “MMT-friendly.”

The decisions about how to issue, lend, and spend money come down to politics, values, and convention, whether the goal is reducing inequality or boosting entrepreneurship. Inflation, MMT’s proponents contend, can be controlled through taxation, and only becomes a problem at full employment, and we’re a long way off from that, particularly if we include people who have given up looking for jobs or aren’t working as much as they’d like to among the officially “unemployed.”

The point is that, once you shake off notions of artificial scarcity, MMT’s possibilities are endless. The state can guarantee a job to anyone who wants one, lowering unemployment and competing with the private sector for workers, raising standards and wages across the board.

MMT didn’t get much traction outside of academia at first. In fact, it was (and remains) on the fringes of the economics profession itself. “We all had offices in the same alley at the Levy Institute,” Kelton recalls.

Then along came Warren Mosler, a wealthy financier who, as a result of his banking work, had come to some unorthodox and complementary ideas about money. Eager to share his views, Mosler finale a meeting with Donald Rumsfeld in the steam room of the Chicago Racquet Club. Rumsfeld led him to Arthur Laffer, the right-wing economist who came up with the “Laffer curve” theory promoting low taxes, and Laffer, in turn, connected Mosler with his future collaborator, the economist Mark McNary. In an independently published paper titled “Soft-Currency Economics,” Mosler, drawing on McNary’s research, argued that taxes are what create a demand for federal spending and that deficits don’t cause countries to default on their debt.

Mosler sought comments on his work from academic departments, too. He didn’t have any luck with Ivy League institutions, but the man made it on Wall Street for at least one reason: He won’t take no for an answer. So Mosler sent his paper to the “Post-Keynesian Thought” listserv and found a group of kindred spirits willing to engage.

Stephanie Kelton recalls initially disagreeing with some of Mosler’s theories about taxes; then her colleague L. Randall Wray told her to do her own work and show how he was mistaken. “I wrote it up in the Cambridge Journal of Economics and set out to prove he was wrong,” Kelton recalls, “but I arrived at the same place he did.”

From then on, Mosler became something like the movement’s sugar daddy, funding graduate research, making donations to the Center for Full Employment and Price Stability at the University of Missouri, even opening a research centre in Switzerland. He was an unlikely addition to the gang: He lives in St. Croix for the taxes, has a thing for fancy cars, made a nice chunk of money investing, and has run for office in St. Croix and in his home state of Connecticut. Mosler isn’t particularly ideological, but after some hesitation, he describes himself over the phone as “basically progressive.” Still, he insists that he is simply opening the public’s eyes to basic math. “It’s a theory insofar as arithmetic is a theory,” Mosler tells me.

“If you eliminate the tax on people working for a living and [let them] keep more money, the average family would have $625 of payroll pay. Why won’t politicians do that? Because they believe the tax money is used to make Social Security payments. But that’s a mistake.” Even so, Mosler notes, “if anyone would propose that, it’s not a big-spending liberal—it’s something the Tea Party might propose.”

Early in his foray into MMT, Mosler hired Bard economist Pavlina Tcherneva to help him with the research. Tcherneva had her 15 minutes of fame in 2015, when Bernie Sanders held up a graph she’d made showing how few gains in income American workers have seen since the Reagan years. (It went viral online under the Vox headline “The most important chart about the American economy you’ll see this year”) Today, Tcherneva’s research is focused on how MMT can provide jobs.

“There is no reason why society should tolerate unemployment,” she tells me in her office at Bard on an unseasonably warm day in February. “It’s a basic human right. By pegging a dollar amount to one hour of labor by having full employment, money will mean something in socially useful terms, and we can design a system to support and tighten the labor market and let people opt out of shitty jobs. Trump has his finger on the pulse of joblessness,” she adds. “It’s a direct recognition, a precise recognition, of their plight. But we need something concrete to offer.”

In Europe, where a generation of young people remain under- or unemployed, more spending, better social welfare, and a guaranteed job are a particularly attractive combination. But eurozone countries share a common currency, so the European Union would have to allow all of its members to borrow more, not less, to stimulate the economies of its more beleaguered states. There is some, if limited, buy-in from governments, though probably nowhere near enough to change the policy. In Greece, for example, Rana Antonopoulos, who runs Bard’s “Gender Equality and the Economy” program, serves as the alternate minister of labor in the Syriza government; she’s proposed pushing the government to be the employer of last resort.

Despite the lack of official interest, austerity has given these MMT economists rock-star status. Kelton recalls a conference a few years back in Rimini, Italy, where her group sold out their initial venue and had to move the event to a basketball stadium. “When we were driving there, the parking lot was packed,” she says. “We asked the driver what was happening, and he said it was for us.” She thought he was kidding—until she saw the MMT signs in the background.

On this side of the Atlantic, the financial crisis, the tepid recovery, and the Occupy movement have paved the way for alternative ways of thinking about the economy, and the events of 2008-12 have made it clear that the US government had the money, it just chose to bail out the banking sector, not spend it on social welfare. This all served to validate many of the points that Kelton and her colleagues have been making for decades.

“We built credibility,” Kelton says, “and that helped us get established as a school of thought. The New Economic Perspectives blog helped us get a voice. It also gave us a historical record about being right about things like how the US downgrade wouldn’t make interest rates go up; that quantitative easing wasn’t inflationary; and that the eurozone would run into trouble. We were saying that in 1998!”

Kelton’s work with Sanders further boosted the gang’s legitimacy. She didn’t transform him into a “deficit owl,” but observers note that during his run, Sanders did make moves to refocus the conversation around social goods, speaking of education, health care, and infrastructure deficits instead of obsessing over abstract negatives on a balance sheet. “He didn’t ‘go there,’” Tcherneva says, “but it was a teachable moment. The frame was useful because it concerns concrete things. People don’t lose sleep over government deficits.”

MMT has something else that most obscure economic doctrines don’t have: a band of devoted bloggers and commenters, and a “street team” of young, politically engaged people who learned about these theories online and have taken it upon themselves to spread the gospel wherever they go with an almost religious fervor.

During the recession, the popular economics blog Naked Capitalism began publishing articles about the movement; economists Tyler Cowen and Paul Krugman, though not particularly sympathetic to MMT (in part because of their concerns about inflation), at least responded to them. In 2012, a Columbia Law School student, Rohan Grey, started a group called the Modern Money Network, which has hosted a series of symposiums with big-name speakers like the former Greek finance minister, Yanis Varoufakis. On YouTube, videos of MMT lectures, seminars, and tutorials abound. “I’ve been amazed by the activism,” Tcherneva says. “We’ve always wanted to democratize our ideas, and we now can thanks to the magic of social media.”

It’s hard to imagine radical changes being made to the way politicians talk about money. It could take decades, even centuries, to make a dent in entrenched ideas about debt, scarcity, and supply. Even so, the time seems ripe for MMT: There is, particularly among young people, an enormous appetite for new solutions to the problems that modern economies face, from automation to offshoring. And the financial crisis has shaken the public’s trust in established ways of thinking. Take the universal basic income: A few years ago, it seemed unrealistic and utopian, but today, versions of the UBI have been embraced by Silicon Valley moguls, economists on the left and the right, and politicians around the world.

MMT is less prescriptive: It describes the way that money works in a way that an 8-year-old can grasp more readily than a PhD, which in itself is unnerving. “The contribution of MMT is not the discovery of new facts,” Galbraith says. “It’s a teaching core of things which are factually uncontroversial.” But its implications can be radically humane. What’s threatening to the establishment, Galbraith adds, “is that the narrative is very compelling.”

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Atossa Araxia Abrahamian is a journalist and the author of The Cosmopolites: The Coming of the Global Citizen

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Modern Monetary Theory is an unconventional take on economic strategy

by Dylan Matthews

About 11 years ago, James K. “Jamie” Galbraith recalls, hundreds of his fellow economists laughed at him. To his face. In the White House.

It was April 2000, and Galbraith had been invited by President Bill Clinton to speak on a panel about the budget surplus. Galbraith was a logical choice. A public policy professor at the University of Texas and former head economist for the Joint Economic Committee, he wrote frequently for the press and testified before Congress.

What’s more, his father, John Kenneth Galbraith, was the most famous economist of his generation: a Harvard professor, best-selling author and confidante of the Kennedy family. Jamie has embraced a role as protector and promoter of the elder’s legacy.

But if Galbraith stood out on the panel, it was because of his offbeat message. Most viewed the budget surplus as opportune: a chance to pay down the national debt, cut taxes, shore up entitlements or pursue new spending programs.

He viewed it as a danger: If the government is running a surplus, money is accruing in government coffers rather than in the hands of ordinary people and companies, where it might be spent and help the economy.

“I said economists used to understand that the running of a surplus was fiscal (economic) drag,” he said, “and with 250 economists, they giggled.”

Galbraith says the 2001 recession — which followed a few years of surpluses — proves he was right.

A decade later, as the soaring federal budget deficit has sharpened political and economic differences in Washington, Galbraith is mostly concerned about the dangers of keeping it too small. He’s a key figure in a core debate among economists about whether deficits are important and in what way. The issue has divided the nation’s best-known economists and inspired pockets of passion in academic circles. Any embrace by policymakers of one view or the other could affect everything from employment to the price of goods to the tax code.

In contrast to “deficit hawks” who want spending cuts and revenue increases now in order to temper the deficit, and “deficit doves” who want to hold off on austerity measures until the economy has recovered, Galbraith is a deficit owl. Deficit Owls certainly don’t think we need to balance the budget soon. Indeed, they don’t concede we need to balance it at all. Owls see government spending that leads to deficits as integral to economic growth, even in good times.

The term isn’t Galbraith’s. It WAS COINED by Stephanie Kelton, a professor at the University of Missouri at Kansas City, who with Galbraith is part of a small group of economists who have concluded that everyone — members of Congress, think tank denizens, the entire mainstream of the economics profession — has misunderstood how the government interacts with the economy. If their theory — dubbed “Modern Monetary Theory” or MMT — is right, then everything we thought we knew about the budget, taxes and the Federal Reserve is wrong.

Keynesian Roots

Modern Monetary Theory” was coined by Bill Mitchell, an Australian economist and prominent proponent, but its roots are much older. The term is a reference to John Maynard Keynes, the founder of modern macroeconomics. In “A Treatise on Money,” Keynes asserted that “all modern States” have had the ability to decide what is money and what is not for at least 4,000 years.

This claim, that money is a “creature of the state,” is central to the theory. In a “fiat money” system like the one in place in the United States, all money is ultimately created by the government, which prints it and puts it into circulation. Consequently, the thinking goes, the government can never run out of money. It can always make more.

This doesn’t mean that taxes are unnecessary. Taxes, in fact, are key to making the whole system work. The need to pay taxes compels people to use the currency printed by the government. Taxes are also sometimes necessary to prevent the economy from overheating. If consumer demand outpaces the supply of available goods, prices will jump, resulting in inflation (where prices rise even as buying power falls). In this case, taxes can tamp down spending and keep prices low.

But if the theory is correct, there is no reason the amount of money the government takes in needs to match up with the amount it spends. Indeed, its followers call for massive tax cuts and deficit spending during recessions.

Warren Mosler, a hedge fund manager who lives in Saint Croix in the U.S. Virgin Islands — in part because of the tax benefits — is one proponent. He’s perhaps better know for his sports car company and his frequent gadfly political campaigns (he earned a little less than one percent of the vote as an independent in Connecticut’s 2010 Senate race). He supports suspending the payroll tax that finances the Social Security trust fund and providing an $8 an hour government job to anyone who wants one to combat the current downturn.

The theory’s followers come mainly from a couple of institutions: the University of Missouri-Kansas City’s economics department and the Levy Economics Institute of Bard College, both of which have received money from Mosler. But the movement is gaining followers quickly, largely through an explosion of economics blogs. Naked Capitalism, an irreverent and passionately written blog on finance and economics with nearly a million monthly readers, features proponents such as Kelton, fellow Missouri professor L. Randall Wray and Wartberg College professor Scott Fullwiler. So does New Deal 2.0, a wonky economics blog based at the liberal Roosevelt Institute think tank.

Their followers have taken to the theory with great enthusiasm and pile into the comment sections of mainstream economics bloggers when they take on the theory. Wray’s work has been picked up by Firedoglake, a major liberal blog, and the New York Times op-ed page. “The crisis helped, but the thing that did it was the blogosphere,” Wray says. “Because, for one thing, we could get it published. It’s very hard to publish anything that sounds outside the mainstream in the journals.”

Most notably, Galbraith has spread the message everywhere from the Daily to Congress. He advised lawmakers including then-House Speaker Nancy Pelosi (D-Calif.) when the financial crisis hit in 2008. Last summer he consulted with a group of House members on the debt ceiling negotiations. He was one of the handful of economists consulted by the Obama administration as it was designing the stimulus package. “I think Jamie has the most to lose by taking this position,” Kelton says. “It was, I think, a really brave thing to do, because he has such a big name, and he’s so well-respected.”

Wray and others say they, too, have consulted with policymakers, and there is a definite sense among the group that the theory’s time is now. “Our Web presence, every few months or so it goes up another notch,” Fullwiler says.

A Divisive History

The idea that deficit spending can help to bring an economy out of recession is an old one. It was a key point in Keynes’s “The General Theory of Employment, Interest and Money.” It was the chief rationale for the 2009 stimulus package, and many self-identified Keynesians, such as former White House adviser Christina Romero and economist Paul Krugman, have argued that more is in order. There are, of course, detractors.

A key split among Keynesians dates to the 1930s. One set of economists, including the Nobel laureates John Hicks and Paul Samuelson, sought to incorporate Keynes’s insights into classical economics. Hicks built a mathematical model summarizing Keynes’s theory, and Samuelson sought to wed Keynesian macroeconomics (which studies the behavior of the economy as a whole) to conventional microeconomics (which looks at how people and businesses allocate resources). This set the stage for most macroeconomic theory since. Even today, “New Keynesians,” such as Greg Mankiw, a Harvard economist who served as chief economic adviser to George W. Bush, and Romer’s husband, David, are seeking ways to ground Keynesian macroeconomic theory in the micro-level behavior of businesses and consumers.

Modern Monetary theorists hold fast to the tradition established by “post-Keynesians” such as Joan Robinson, Nicholas Kaldor and Hyman Minsky, who insisted Samuelson’s theory failed because its models acted as if, in Galbraith’s words, “the banking sector doesn’t exist.”

The connections are personal as well. Wray’s doctoral dissertation was advised by Minsky, and Galbraith studied with Robinson and Kaldor at the University of Cambridge. He argues that the theory is part of an “alternative tradition, which runs through Keynes and my father and Minsky.

And while Modern Monetary Theory’s proponents take Keynes as their starting point and advocate aggressive deficit spending during recessions, they’re not that type of Keynesians. Even mainstream economists who argue for more deficit spending are reluctant to accept the central tenets of Modern Monetary Theory. Take Krugman, who regularly engages economists across the spectrum in spirited debate. He has argued that pursuing large budget deficits during boom times can lead to hyperinflation. Mankiw concedes the theory’s point that the government can never run out of money but doesn’t think this means what its proponents think it does.

Technically it’s true, he says, that the government could print streams of money and never default. The risk is that it could trigger a very high rate of inflation. This would “bankrupt much of the banking system,” he says. “Default, painful as it would be, might be a better option.”

Mankiw’s critique goes to the heart of the debate about Modern Monetary Theory — and about how, when and even whether to eliminate our current deficits.

When the government deficit spends, it issues bonds to be bought on the open market. If its debt load grows too large, mainstream economists say, bond purchasers will demand higher interest rates, and the government will have to pay more in interest payments, which in turn adds to the debt load.

To get out of this cycle, the Fed — which manages the nation’s money supply and credit and sits at the center of its financial system — could buy the bonds at lower rates, bypassing the private market. The Fed is prohibited from buying bonds directly from the Treasury — a legal rather than economic constraint. But the Fed would buy the bonds with money it prints, which means the money supply would increase. With it, inflation would rise, and so would the prospects of hyperinflation.

“You can’t just fund any level of government that you want from spending money, because you’ll get runaway inflation and eventually the rate of inflation will increase faster than the rate that you’re extracting resources from the economy,” says Karl Smith, an economist at the University of North Carolina. “This is the classic hyperinflation problem that happened in Zimbabwe and the Weimar Republic.”

The risk of inflation keeps most mainstream economists and policymakers on the same page about deficits: In the medium term — all else being equal — it’s critical to keep them small.

Economists in the Modern Monetary camp concede that deficits can sometimes lead to inflation. But they argue that this can only happen when the economy is at full employment — when all who are able and willing to work are employed and no resources (labor, capital, etc.) are idle. No modern example of this problem comes to mind, Galbraith says.

“The last time we had what could be plausibly called a demand-driven, serious inflation problem was probably World War I,” Galbraith says. “It’s been a long time since this hypothetical possibility has actually been observed, and it was observed only under conditions that will never be repeated.”

Critics Rebuttals

According to Galbraith and the others, monetary policy as currently conducted by the Fed does not work. The Fed generally uses one of two levers to increase growth and employment. It can lower short-term interest rates by buying up short-term government bonds on the open market. If short-term rates are near-zero, as they are now, the Fed can try “quantitative easing,” or large-scale purchases of assets (such as bonds) from the private sector including longer-term Treasuries using money the Fed creates. This is what the Fed did in 2008 and 2010, in an emergency effort to boost the economy.

According to Modern Monetary Theory, the Fed buying up Treasuries is just, in Galbraith’s words, a “bookkeeping operation” that does not add income to American households and thus cannot be inflationary.

“It seemed clear to me that . . . flooding the economy with money by buying up government bonds . . . is not going to change anybody’s behavior,” Galbraith says. “They would just end up with cash reserves which would sit idle in the banking system, and that is exactly what in fact happened.”

The theorists just “have no idea how quantitative easing works,” says Joe Gagnon, an economist at the Peterson Institute who managed the Fed’s first round of quantitative easing in 2008. Even if the money the Fed uses to buy bonds stays in bank reserves — or money that’s held in reserve — increasing those reserves should still lead to increased borrowing and ripple throughout the system.

Mainstreamers are equally baffled by another claim of the theory: that budget surpluses in and of themselves are bad for the economy. According to Modern Monetary Theory, when the government runs a surplus, it is a net saver, which means that the private sector is a net debtor. The government is, in effect, “taking money from private pockets and forcing them to make that up by going deeper into debt,” Galbraith says, reiterating his White House comments.

The mainstream crowd finds this argument as funny now as they did when Galbraith presented it to Clinton. “I have two words to answer that: Australia and Canada,” Gagnon says. “If Jamie Galbraith would look them up, he would see immediate proof he’s wrong. Australia has had a long-running budget surplus now, they actually have no national debt whatsoever, they’re the fastest-growing, healthiest economy in the world.” Canada, similarly, has run consistent surpluses while achieving high growth.

To even care about such questions, Galbraith says, marked him as “a considerable eccentric” when he arrived from Cambridge to get a PhD at Yale, which had a more conventionally Keynesian economics department. Galbraith credits Samuelson and his allies’ success to a “mass-marketing of economic doctrine, of which Samuelson was the great master . . .which is something the Cambridge school could never have done.”

The mainstream economists are loath to give up any ground, even in cases such as the so-called “Cambridge capital controversy” of the 1960s. Samuelson debated post-Keynesians and, by his own admission, lost. Such matters have been, in Galbraith’s words, “airbrushed, like Trotsky” from the history of economics.

But MMT’s own relationship to real-world cases can be a little hit-or-miss. Mosler, the hedge fund manager, credits his role in the movement to an epiphany in the early 1990s, when markets grew concerned that Italy was about to default. Mosler figured that Italy, which at that time still issued its own currency, the lira, could not default as long as it had the ability to print more liras. He bet accordingly, and when Italy did not default, he made a tidy sum. “There was an enormous amount of money to be made if you could bring yourself around to the idea that they couldn’t default,” he says.

Later that decade, he learned there was also a lot of money to be lost. When similar fears surfaced about Russia, he again bet against default. Despite having its own currency, Russia defaulted, forcing Mosler to liquidate one of his funds and wiping out much of his $850 million in investments in the country. Mosler credits this to Russia’s fixed exchange rate policy of the time and insists that if it had only acted like a country with its own currency, default could have been avoided.

But the case could also prove what critics insist: Default, while technically always avoidable, is sometimes the best available option.

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Wikipedia
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Modern Monetary Theory
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MMT or Modern Money Theory, also known as Neo-Chartalism, is a macroeconomic theory that describes and analyses modern economies in which the national currency is fiat money, established and created by the government.
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The key insight of MMT is that “monetarily sovereign government is the monopoly supplier of its currency and can issue currency of any denomination in physical or non-physical forms. As such the government has an unlimited capacity to pay for the things it wishes to purchase and to fulfill promised future payments, and has an unlimited ability to provide funds to the other sectors. Thus, insolvency and bankruptcy of this government is not possible. It can always pay.”
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In sovereign financial systems, banks can create money but these “horizontal” transactions do not increase net financial assets as assets are offset by liabilities. “The balance sheet of the government does not include any domestic monetary instrument on its asset side; it owns no money. All monetary instruments issued by the government are on its liability side and are created and destroyed with spending and taxing/bond offerings, respectively.”
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In addition to deficit spending, valuation effects (e.g. growth in stock price) can increase net financial assets. In MMT, “vertical” money (see below) enters circulation through government spending.
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Taxation and its Legatum tender enable power to discharge debt and establish the fiat money as currency, giving it value by creating demand for it in the form of a private tax obligation that must be met.
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In addition, fines, fees and licenses create demand for the currency. This can be a currency issued by the government, or a foreign currency such as the Euro.
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An ongoing tax obligation, in concert with private confidence and acceptance of the currency, maintains its value. Because the government
can issue its own currency at will, MMT maintains that the level of taxation relative to government spending (the government’s deficit spending or budget surplus) is in reality a policy tool that regulates inflation and unemployment, and not a means of funding the government’s activities by itself.
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Theoretical Background
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MMT synthesises ideas from the State Theory of Money of Georg Friedrich Knapp (also known as Chartalism) and Credit Theory of Money of Alfred Mitchell-Innes, the functional finance proposals of Abba Lerner, Hyman Minsky‘s views on the banking system and Wynne Godley‘s Sectoral balances approach.
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Knapp, writing in 1905, argued that “money is a creature of law” rather than a commodity. At the time of writing the Gold Standard was in existence, and Knapp contrasted his state theory of money with the view of “metallism“, where the value of a unit of currency depended on the quantity of precious metal it contained or could be exchanged for. He argued the state can create pure paper money and make it exchangeable by recognising it as legal tender, with the criterion for the money of a state being “that which is accepted at the public pay offices”.
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The prevailing view of money was that it had evolved from systems of barter to become a medium of exchange because it represented a durable commodity which had some use value, but proponents of MMT such as Randall Wray and Mathew Forstater argue that more general statements appearing to support a chartalist view of tax-driven paper money appear in the earlier writings of many classical economists, including Adam Smith, Jean-Baptiste Say, J.S. Mill, Karl Marxand William Stanley Jevons
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Alfred Mitchell-Innes, writing in 1914, argued that money existed not as a medium of exchange but as a standard of deferred payment, with government money being debt the government could reclaim by taxation. Innes argued:
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Whenever a tax is imposed, each taxpayer becomes responsible for the redemption of a small part of the debt which the government has contracted by its issues of money, whether coins, certificates, notes, drafts on the treasury, or by whatever name this money is called. He has to acquire his portion of the debt from some holder of a coin or certificate or other form of government money, and present it to the Treasury in liquidation of his legal debt. He has to redeem or cancel that portion of the debt…The redemption of government debt by taxation is the basic law of coinage and of any issue of government ‘money’ in whatever form.
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— Alfred Mitchell-Innes, The Credit Theory of Money, The Banking Law Journal
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Knapp and “chartalism” were referenced by John Maynard Keynes in the opening pages of his 1930 Treatise on Money and appear to have influenced Keynesian ideas on the role of the state in the economy.
By 1947, when Abba Lerner wrote his article Money as a Creature of the State, economists had largely abandoned the idea that the value of money was closely linked to gold.
Lerner argued that responsibility for avoiding inflation and depressions lay with the state because of its ability to create or tax away money
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Vertical Transactions
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MMT labels any transactions between the government sector and the non-government sector as a vertical transaction. The government sector is considered to include the treasury and the central bank, whereas the non-government sector includes private individuals and firms (including the private banking system) and the external sector – that is, foreign buyers and sellers.
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In any given time period, the government’s budget can be either in deficit or in surplus. A deficit occurs when the government spends more than it taxes; and a surplus occurs when a government taxes more than it spends. MMT states that as a matter of accounting, it follows that government budget deficits add net financial assets to the private sector. This is because a budget deficit means that a government has deposited more money into private bank accounts than it has removed in taxes. A budget surplus means the opposite: in total, the government has removed more money from private bank accounts via taxes than it has put back in via spending.
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Therefore, budget deficits add net financial assets to the private sector; whereas budget surpluses remove financial assets from the private sector. This is widely represented in macroeconomic theory by the national income identity:
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GT = SINX
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where G is government spending, T is taxes, Sis savings, I is investment and NX is net exports.
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The conclusion that MMT draws from this is that it is only possible for the non government sector to accumulate a surplus if the government runs budget deficits. The non government sector can be further split into foreign users of the currency and domestic users.
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MMT economists aim to run deficits as much as the private sector wants to save and for real resources to be fully used e.g. full employment. As most private sectors want to net save and globally, external balances must add up to zero, MMT economists usually advocate budget deficits.
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Interaction between government and the banking sector
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MMT is based on a detailed empirical account of the “operational realities” of interactions between the government and its central bank, and the commercial banking sector, with proponents like Scott Fullwiler arguing that understanding of reserve accounting is critical to understanding monetary policy options.
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A sovereign government typically has an operating account with the country’s central bank. From this account, the government can spend and also receive taxes and other inflows. All of the commercial banks also have an account with the central bank, by means of which the banks manage their reserves (that is, the amount of available short-term money that a particular bank holds).
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So when the government spends, the treasury debits its operating account at the central bank, and deposits this money into private bank accounts (and hence into the commercial banking system). This money adds to the total deposits in the commercial bank sector. Taxation works exactly in reverse; private bank accounts are debited, and hence deposits in the commercial banking sector fall.
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Government bonds and interest rate maintenance
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Virtually all central banks set an interest rate target, and conduct open market operationsto ensure base interest rates remain at that target level. According to MMT the issuing of government bonds is best understood as an operation to offset government spending rather than a requirement to finance it.
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In most countries, commercial banks’ reserve accounts with the central bank must have a positive balance at the end of every day; in some countries, the amount is specifically set as a proportion of the liabilities a bank has (i.e. its customer deposits). This is known as a reserve requirement. At the end of every day, a commercial bank will have to examine the status of their reserve accounts. Those that are in deficit have the option of borrowing the required funds from the central bank, where they may be charged a lending rate(sometimes known as a discount rate) on the amount they borrow. On the other hand, the banks that have excess reserves can simply leave them with the central bank and earn a support rate from the central bank. Some countries, such as Japan, have a support rate of zero.
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Banks with more reserves than they need will be willing to lend to banks with a reserve shortage on the interbank lending market. The surplus banks will want to earn a higher rate than the support rate that the central bank pays on reserves; whereas the deficit banks will want to pay a lower interest rate than the discount rate the central bank charges for borrowing. Thus they will lend to each other until each bank has reached their reserve requirement. In a balanced system, where there are just enough total reserves for all the banks to meet requirements, the short-term interbank lending rate will be in between the support rate and the discount rate.
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Under an MMT framework where government spending injects new reserves into the commercial banking system, and taxes withdraw it from the banking system, government activity would have an instant effect on interbank lending. If on a particular day, the government spends more than it taxes, reserves have been added to the banking system (see vertical transactions). This will typically lead to a system-wide surplus of reserves, with competition between banks seeking to lend their excess reserves forcing the short-term interest rate down to the support rate (or alternately, to zero if a support rate is not in place). At this point banks will simply keep their reserve surplus with their central bank and earn the support rate.
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The alternate case is where the government receives more taxes on a particular day than it spends. In this case, there may be a system-wide deficit of reserves. As a result, surplus funds will be in demand on the interbank market, and thus the short-term interest rate will rise towards the discount rate. Thus, if the central bank wants to maintain a target interest rate somewhere between the support rate and the discount rate, it must manage the liquidity in the system to ensure that there is the correct amount of reserves in the banking system.
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Central banks manage this by buying and selling government bonds on the open market. On a day where there are excess reserves in the banking system, the central bank sells bonds and therefore removes reserves from the banking system, as private individuals pay for the bonds. On a day where there are not enough reserves in the system, the central bank buys government bonds from the private sector, and therefore adds reserves to the banking system.
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It is important to note that the central bank buys bonds by simply creating money—it is not financed in any way. It is a net injection of reserves into the banking system. If a central bank is to maintain a target interest rate, then it must necessarily buy and sell government bonds on the open market in order to maintain the correct amount of reserves in the system.
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Horizontal Transactions
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MMT economists describe any transactions within the private sector as “horizontal” transactions, including the expansion of the broad money supply through the extension of credit by banks.
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MMT economists regard the concept of the money multiplier, where a bank is completely constrained in lending through the deposits it holds and its capital requirement, as misleading. Rather than being a practical limitation on lending, the cost of borrowing funds from the interbank market (or the central bank) represents a profitability consideration when the private bank lends in excess of its reserve and/or capital requirements (see interaction between government and the banking sector).
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According to MMT, bank credit should be regarded as a “leverage” of the monetary baseand should not be regarded as increasing the net financial assets held by an economy: only the government or central bank is able to issue high-powered money with no corresponding liability. Stephanie Kelton argues that bank money is generally accepted in settlement of debt and taxes because of state guarantees, but that state-issued high-powered money sits atop a “hierarchy of money”.
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The Foreign Sector
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NOTE: Some MMT economists view this distinction as misleading, regarding the currency area itself as a closed system, and do not differentiate between the external and domestic sectors. They view the world (closed system) split into several currency areas, not necessarily the size of a country.
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Imports and exports
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MMT analyzes imports and exports within the framework of horizontal transactions. It argues that an export represents a desire on behalf of the exporting nation to obtain the national currency of the importing nation if there are floating exchange rates and they use different currencies. The following hypothetical example is consistent with the workings of the FX market, and can be used to illustrate the basis of this aspect of MMT:
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”An Australian importer (person A) needs to pay for some Japanese goods. The importer will go to his bank and ask to transfer 1000 yen to the Japanese bank account of the Japanese firm (person B). After looking up the relevant exchange rates for that day, the bank will inform him that this will cost him 10 dollars. The bank removes 10 dollars from the importer’s account, and goes to the FX market. It finds an individual (person C) who is willing to swap 1000 yen for 10 dollars. It transfers the 10 dollars to that individual. Then it takes the 1000 yen and transfers it to the Japanese exporter’s bank account.”
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Thus, the transaction is complete. What made the transaction possible (i.e. acceptably priced to the importer) was person C in the middle of the FX swap. Thus MMT concludes that it is a foreign desire for an importer’s currency that makes importing possible.
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MMT proponents such as Warren Mosler argue that trade deficits need not be unsustainable and are beneficial to the standard of living in the short run. Imports are an economic benefit to the importing nation because they provide the nation with real goods it can consume, that it otherwise would not have had. Exports, on the other hand, are an economic cost to the exporting nation because it is losing real goods that it could have consumed. Currency transferred to foreign ownership, however represents a future claim over goods of that nation.
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Cheap imports may also cause the failure of local firms providing similar goods at higher prices, and hence unemployment but MMT commentators label that consideration as a subjective value-based one, rather than an economic-based one: it is up to a nation to decide whether it values the benefit of cheaper imports more than it values employment in a particular industry. Similarly a nation overly dependent on imports may face a supply shock if the exchange rate drops significantly, though central banks can and do trade on the FX markets to avoid sharp shocks to the exchange rate.
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Foreign sector and commercial banks
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Although a net-importing nation will transfer a portion of domestic currency into foreign ownership, the currency will usually remain within the importing nation. The foreign owner of the local currency can either (a) spend them purchasing local assets or (b) deposit them in the local banking system. In each scenario, the money ultimately ends up in the local banking system.
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Foreign sector and government
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Using the same application of vertical transactions MMT argues that the holder of the bond is irrelevant to the issuing government. As long as there is a demand for the issuer’s currency, whether the bond holder is foreign or not, governments can never be insolvent when the debt obligations are in their own currency; this is because the government is not constrained in creating its own currency (although the bond holder may affect the exchange rate by converting to local currency). Similarly, according to the FX theory outlined above, the currency paid out at maturity cannot leave the country of issuance either.
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MMT does point out, however, that debt denominated in a foreign currency certainly is a fiscal risk to governments, since the indebted government cannot create foreign currency. In this case the only way the government can sustainably repay its foreign debt is to ensure that its currency is continually and highly demanded by foreigners over the period that it wishes to repay the debt – an exchange rate collapse would potentially multiply the debt many times over asymptotically, making it impossible to repay. In that case, the government can default, or attempt to shift to an export-led strategy or raise interest rates to attract foreign investment in the currency. Either one has a negative effect on the economy. Euro debt crises in the “PIIGS” countries that began in 2009 reflect this risk, since Greece, Ireland, Spain, Italy, etc. have all issued debts in a quasi-“foreign currency” – the Euro, which they cannot create.
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Policy Implications
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MMT claims that the word “borrowing” is a misnomer when it comes to a sovereign government’s fiscal operations, because what the government is doing is accepting back its own IOUs, and nobody can borrow back their own debt instruments. Sovereign government goes into debt by issuing its own liabilities that are financial wealth to the private sector. “Private debt is debt, but government debt is financial wealth to the private sector.”
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In this theory, sovereign government is not financially constrained in its ability to spend; it is argued that the government can afford to buy anything that is for sale in currency that it issues (there may be political constraints, like a debt ceiling law). The only constraint is that excessive spending by any sector of the economy (whether households, firms or public) has the potential to cause inflationary pressures.
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Some MMT economists advocate a government-funded job guarantee scheme to eliminate involuntary unemployment. Proponents argue that this can be consistent with price stability as it targets unemployment directly rather than attempting to increase private sector job creation indirectly through a much larger economic stimulus, and maintains a “buffer stock” of labor that can readily switch to the private sector when jobs become available. A job guarantee program could also be considered a powerful automatic stabilizer to the economy, expanding when private sector activity cools down and shrinking in size when private sector activity heats up.
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Criticisms
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The post-Keynesian economist Thomas Palleyargues that MMT is largely a restatement of elementary Keynesian economics, but prone to “over-simplistic analysis” and understating the risks of its policy implications. Palley denies the MMT claim that standard Keynesian analysis doesn’t fully capture the accounting identities and financial restraints on a government that can issue its own money. He argues that these insights are well captured by standard Keynesian stock-flow consistent IS-LM models, and have been well understood by Keynesian economists for decades. He also criticizes MMT for essentially assuming away the problem of fiscal – monetary conflict. In Palley’s view the policies proposed by MMT proponents would cause serious financial instability in an open economy with flexible exchange rates, while using fixed exchange rates would restore hard financial constraints on the government and “undermines MMT’s main claim about sovereign money freeing governments from standard market disciplines and financial constraints”. He also argues that MMT lacks a plausible theory of inflation, particularly in the context of full employment in the ‘Employer of last resort‘ policy first proposed by Minsky and advocated by Bill Mitchell and other MMT theorists; of a lack of appreciation of the financial instability that could be caused by permanently zero interest rates; and of overstating the importance of government created money. Palley concludes that MMT provides no new insights about monetary theory, while making unsubstantiated claims about macroeconomic policy, and that MMT has only received attention recently due to it being a “policy polemic for depressed times”.
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Marc Lavoie argues that whilst the neochartalist argument is “essentially correct”, many of its counter-intuitive claims depend on a “confusing” and “fictitious” consolidation of government and central banking operations.
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Austrian School economist Robert P. Murphy states that MMT is “dead wrong” and that “the MMT worldview doesn’t live up to its promises”. He observes that the MMT claim that cutting government deficits erodes private saving is true only for the portion of private saving that is not invested, and argues that the national accounting identities used to explain this aspect of MMT could equally be used to support arguments that government deficits “crowd out” private sector investment. Daniel Kuehn has voiced his agreement with Murphy, stating “it’s bad economics to confuse accounting identities with behavioral laws […] economics is not accounting.”
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New Keynesian economist and Nobel laureate Paul Krugman argues that MMT goes too far in its support for government budget deficits and ignores the inflationary implications of maintaining budget deficits when the economy is growing.
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The chartalist view of money itself, and the MMT emphasis on the importance of taxes in driving money is also a source of criticism. Economist Eladio Febrero argues that modern money draws its value from its ability to cancel (private) bank debt, particularly as legal tender, rather than to pay government taxes.
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Modern Proponents
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Economists Warren Mosler, L. Randall Wray, Stephanie Kelton, Bill Mitchell and Pavlina R. Tcherneva are largely responsible for reviving the idea of chartalism as an explanation of money creation; Wray refers to this revived formulation as Neo-Chartalism.
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Bill Mitchell, Professor of Economics and Director of the Centre of Full Employment and Equity or CofFEE, at the University of Newcastle, New South Wales, refers to an increasing related theoretical work as Modern Monetary Theory.
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Pavlina R. Tcherneva has developed the first mathematical framework for MMT and has largely focused on developing the idea of the Job Guarantee.
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Scott Fullwiler has added detailed technical analysis of the banking and monetary systems.
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Rodger Malcolm Mitchell’s book Free Money (1996) describes in layman’s terms the essence of chartalism.
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Some contemporary proponents, such as Wray, situate chartalism within post-Keynesian economics, while chartalism has been proposed as an alternative or complementary theory to monetary circuit theory, both being forms of endogenous money, i.e., money created within the economy, as by government deficit spending or bank lending, rather than from outside, as by gold. In the complementary view, chartalism explains the “vertical” (government-to-private and vice versa) interactions, while circuit theory is a model of the “horizontal” (private-to-private) interactions.
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Hyman Minsky seemed to favor a chartalist approach to understanding money creation in his Stabilizing an Unstable Economy, while Basil Moore, in his book Horizontalists and Verticalists, delineates the differences between bank money and state money.
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James K. Galbraith supports chartalism and wrote the foreword for Mosler’s book Seven Deadly Innocent Frauds of Economic Policy in 2010.
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Steven Hail of the University of Adelaide is another well known MMT economist.

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