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MODERN MONETARY THEORY, Basic Principles – Bill Mitchell.

Any economic system, short of slavery, requires productive resources to be transferred, through free will, taxation, from the non-government sector to the government sector in order to do the work of the latter.

The state, generally through its designated agent, the central bank, is the sole supplier of that which it demands for payment of taxes, it’s fiat currency. The taxpayers do not have the capacity to meet their legal tax obligations defined by the state without the state acting first, spending on goods and services from the non-government sector.

Tax liabilities (not tax payments) function to create sellers of goods and services in exchange for the required state tax credits, the latter which we refer to in common parlance as the state’s currency.

State spending therefore, is constrained by what is offered for sale in response to tax liabilities. Spending by such a government is not operationally constrained by revenues, rather it is constrained by the availability of goods and services to buy in the non-government sector.

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MMT BEDROCK

There can be no net savings of financial assets in the non-government sector without cumulative government deficit spending.

The government, as the currency monopolist, is the only entity that can provide the non-government sector with net financial assets (net savings) and thereby simultaneously accommodate any net desire to save (financial assets) and eliminate mass unemployment.

In accounting terms, the government’s deficit (surplus) is exactly equal at all times to the non-government sector’s surplus (deficit).

There is a tendency in the social media to use the term MMT as a slogan rather than relating to it as a coherent body of academic work in economic theory and practice that has been meticulously developed over more than 25 years.

This tendency manifests in claims that the essence of MMT is that the capacity of the government to fund programs is unlimited and so there is massive scope for all sorts of progressive policies to be introduced.

Basic Principle 1: The beginning of the MMT ‘money story’

Societies that use state money are very different to a barter-type system.

In a monetary society, the state is at the top of the monetary hierarchy. We cannot understand how such a system works unless we understand the functions of the state in this respect.

The MMT ‘money story’ begins with a state desiring to provision itself in order to fulfill the political charter for which it was elected by the people. That meaning applies to democratic systems where the politicians go to the people with a stated mission and the winner forms government.

However, the ’money story’ is not exclusive to democracies;

Any system, short of slavery, requires productive resources to be transferred, through free will, from the non-government sector to the government sector in order to do the work of the latter.

That insight is the beginning of our journey.

Further, the state (generally through its designated agent, the central bank) is the sole supplier of that which it demands for payment of taxes. The taxpayers do not have the capacity to meet their legal tax obligations defined by the state without the state acting first.

But the imposition of the tax liability is an important step in the ‘money story’ to understand. What it means is that the tax liabilities (not tax payments) function to create sellers of goods and services in exchange for the required state tax credits, the latter which we refer to in common parlance as the state’s currency.

So we can think of a currency as being a tax credit with the state.

This provides a further insight that is intrinsic to MMT.

The tax liabilities function to create what we define as unemployment, where people seek work in exchange for the state’s currency.

Thus taxation is a way that the government can elicit productive resources and final goods and services from the non-government sector that it needs to advance its political agenda. It is clear that the non-government sector has to get the currency before it can use it to pay its tax bills.

Where else could the non-government sector get the currency from to meet its legal liabilities to the government, if the latter did not purchase goods and services provided by the non-government sector or make transfers to that sector?

So the state can then provision itself by buying what is being offered for sale with it’s otherwise useless currency.

And thus we understand the basic operations involved.

The state, from inception, as the sole supplier of the funds needed to pay taxes or buy the debt issued by the state, must necessarily impose tax liabilities on the non-government sector before it can spend.

Given that the non-government sector requires fiat currency to pay its taxation liabilities, in the first instance, the imposition of taxes, without a concomitant injection of public spending, by design, creates unemployment (people seeking paid work) in the non-government sector.

The unemployed or idle non-government resources can then be utilised through government spending, which amounts to a transfer of real goods and services from the non-government sector to the government sector.

While real resources are transferred from the non-government sector in the form of goods and services that are purchased by government, the motivation to supply these resources is sourced back to the need to acquire fiat currency to extinguish the tax liabilities.

Further, while real resources are transferred, the taxation provides no additional financial capacity to the government of issue.

Conceptualising the relationship between the government and non-government sectors in this way makes it clear that it is government spending that provides the paid work which eliminates the unemployment created by the taxes.

This understanding provides a further insight.

State spending therefore, is constrained by what is offered for sale in response to tax liabilities.

But, importantly, spending by such a government is not operationally constrained by revenues.

Note here that this conclusion does not apply to the 19 Member States of the Eurozone because they surrendered their currency sovereignty and use a foreign currency instead.

Basic Principle 2: The unemployment and Job Guarantee story

In a normal functioning economy, there will always be some unemployment as people move between jobs. Typically this state should be transitory and a low percentage of those willing and available for work. We call this an irreducible level of unemployment and it might be around 1 to 2 per cent, depending on the nation.

Unemployment in excess of that irreducible minimum is called mass unemployment.

And, bringing together the initial insights above we can conclude that unemployment is the evidence that state spending is insufficient to have hired all people that the state’s taxation has caused to become unemployed.

In the Post-World War 2 period where the so-called ‘Keynesian’ consensus operated, mass unemployment was referred to as ’demand-deficient’ unemployment, which described a situation where there is a shortage of jobs overall relative to the willing supply of labour resources (persons and hours) at the current wage levels.

The tag went beyond description though because it indicated that such unemployment arose because of a deficiency in aggregate spending.

Mass unemployment thus varies over the economic cycle, rising when aggregate spending falls below the level needed to fully employ the available workforce and falling when aggregate spending moves closer to the level needed to fully employ the available supply of labour.

This conception is fully consistent with the way MMT characterises mass unemployment. The difference is the emphasis MMT places on the role of government and the operations of the tax liabilities.

Thus, mass unemployment arises because, after the non-government sector has implemented its spending and saving decisions, the level of spending is insufficient to create sales and output commensurate with the provision of jobs necessary to absorb the willing and available supply of labour.

The MMT emphasis is that this jobs shortage arises because for a given state of tax liabilities, government spending is insufficient.

We thus understand that the remedy is to either to spend more into the Non-government sector (which may involve hiring the unemployed directly) and/or reducing the tax liabilities.

Warren Mosler would say that the government should do this until the unemployed transition back to the non-government sector.

His view is that, initially, the government should provision itself as desired to the ’right size’ as explained. And once the government is at it’s desired ‘right size’ the remaining unemployed can be transitioned back to the private sector.

I would express this a little differently by allowing the possibility that the Job Guarantee pool could be a permanent employment location for some workers if they so choose. Having a small fairly rigid buffer doesn’t reduce its price stability features.

I also understand that one could make a case to render these jobs permanent within the non-Job Guarantee part of the public sector, which then relates directly to Warren’s reference to the ‘right size’.

But the point is that the currency-issuing government always chooses the prevailing unemployment once the spending and saving decisions of the non-government sector are implemented.

In the current era, governments use the unemployed as a buffer stock to provide a price anchor for wages in the general economy.

In the ‘Keynesian’ full employment period, governments saw mass unemployment as a policy target to be kept as low as possible within inflation limits they believed existed.

But in the neoliberal era, governments use unemployment as a policy tool to discipline wage demands and soften sales (thus putting a discipline on firms who might concede wage demands).

The unemployed buffer stock approach (sometimes called the NAIRU approach) is the way in which inflation control is managed.

However, the longer people stay unemployed the higher is the skill loss and non-government employers tend to prefer to hire from those already working or who have been unemployed for only short periods of time.

In other words, the disciplining power of unemployment requires that the unemployed constitute a threat to those still in work so that they will moderate their wage demands.

However, over time, the threat from this unemployment pool starts to wane as the unemployed endure skill losses and firms introduce new technologies and processes.

In this case, the so-called NAIRU has to be pushed higher and higher by contractionary fiscal and monetary policy for the same degree of threat to be maintained.

There are also massive costs involved in both income loss and personal pathologies (social exclusion, psychological harm, et) that further compound the overall disadvantages of the unemployment buffer stock price anchor.

On any reasonable grounds, this approach to price stability is very costly and ultimately, unworkable in a modern economy. High and sustained levels of unemployment, ultimately, undermine the social and political stability of a nation, which creates unintended costs that go far beyond those noted above.

The MMT alternative is that the government introduces a Job Guarantee policy to establish an employed buffer stock which provides a superior price anchor than the current policy that uses unemployment as a buffer stock.

Warren sees the employed buffer stock as a means to promote the transition from unemployment to private sector employment.

I see that it can do that but may also be a permanent pool of workers who will never be able to gain private sector employment at current wages. My bias is not to privilege non-government employment over public employment.

But that doesn’t alter the fact that the Job Guarantee is an anti-inflation policy that further renders the positive externalities of higher paying jobs for anyone willing and able to work.

The Job Guarantee is a macroeconomic stability approach, which means it is much more than a simple public sector job creation policy.

As MMT has gained in popularity, there have been a number of different job guarantee proposals coming out of the woodwork, many of which claim to be derived from MMT.

Note the use of the lower case j and g in the previous paragraph.

However, there is only one Job Guarantee in MMT.

The Job Guarantee within MMT is a technical construct designed to replace the mainstream Phillips curve (the tradeoff between unemployment and inflation).

The Job Guarantee is a superior buffer stock mechanism to mass unemployment for maintaining price stability.

And this means, that even if one didn’t hold the philosophical or moral commitment to the ‘right to work’ they would still advocate a Job Guarantee (MMT style) in contradistinction to the NAIRU-approach which uses unemployment as the buffer stock price anchor.

They would have to agree that in efficiency terms, which relates to resource wastage etc, the employment buffer stock approach is superior to the current dominant alternative.

The Job Guarantee disciplines inflation because the government offers anyone a job at a fixed wage that is at the bottom of the wage structure.

In times of inflation pressures, the government can use fiscal policy to redistribute workers from the inflating sector to the fixed price Job Guarantee sector.

Clearly, it is desirable to keep the Job Guarantee buffer stock at a minimum.

And so fiscal policy adjustments can be implemented to keep the Job Guarantee pool at minimum required levels to achieve desired price stability.

Basic Principle 3: The Public Debt story

In trying to understand, the issuance of public debt, we note that funds spent by the State into the non-government sector (for goods and services) is either lost to the economy when taxes are paid, or remains in the economy as savings until used to pay taxes.

That is just a matter of accounting. The ‘savings‘ are stored as financial assets in various forms.

As a matter of accounting between the sectors, a government fiscal deficit (spending that isn’t matched by taxes) adds net financial assets (adding to non government savings) available to the non-government sector and a fiscal surplus has the opposite effect.

The last point requires further explanation as it is crucial to understanding the basis of MMT.

Given the current bias toward (unnecessarily) matching fiscal deficits (spending greater than tax withdrawals) we say that what is commonly termed the ‘public debt’ is really just the accounting record of the savings, the funds spent by the state that have not yet been used to pay taxes.

In aggregate, there can be no net savings of financial assets of the non-government sector without cumulative government deficit spending.

The government, as the currency monopolist, is the only entity that can provide the non-government sector with net financial assets (net savings) and thereby simultaneously accommodate any net desire to save (financial assets) and eliminate mass unemployment.

In accounting terms, the government’s deficit (surplus) is exactly equal at all times the non-government sector’s surplus (deficit).

All this ties in with our previous discussion by allowing us to see the limits on government spending.

It is clear that government spending has to be sufficient to allow taxes to be paid.

In addition, net government spending is required to meet the private desire to save (accumulate net financial assets).

It is also clear that if the Government doesn’t spend enough to cover the taxes to be paid and the non-government sector’s desire to save overall, then the manifestation of this deficiency will be unemployment.

In MMT, the basis of this deficiency is at all times inadequate net government spending, given the private spending (saving) decisions in force at any particular time.

Further, fiscal deficits manifest in the non-government sector as actual cash balances in banks and credit balances in reserve accounts and securities (debt) accounts that are maintained by the central bank in the nation.

All commercial banks hold reserves at the central bank as part of the ‘clearing system’, so that all the transactions that occur on a daily basis can be validated and resolved.

The debt accounts record the outstanding government debt in various forms (short-term and long-term) that has been issued to match the fiscal deficits.

If you think about the process through which net government spending initially create an increase in net financial assets in the non-govemment sector you will appreciate that spending effectively involves the government crediting bank accounts in the non-government sector and taxing involves the government marking down bank account balances.

A fiscal deficit means there is a net accretion in these accounts. Initially, after all the transactions are made between government and non-government and within the non-government sector, that net accretion shows up as increases in the banks’ reserve accounts at the central bank.

Interest may or may not be paid on those balances.

If the deficit is matched dollar-for-dollar with debt issuance then the government would debit (mark down) the balances in the reserve accounts (of the banks that were party to the debt purchases directly or through their clients) and credit (mark up) another ‘account’ which we can call ‘outstanding public debt’.

In other words, the debt issuance effectively just results in funds in reserve accounts being transferred to funds in the ‘outstanding public debt’ account.

When specific debt items (bonds) mature (that is, reaches the time that the government has to pay back the principal), a reverse operation would occur.

The ‘outstanding public debt’ account would be debited (marked down) and bank reserves would be credited (marked up).

And if the central bank was to pay market rate of interest on reserve balances (as many are currently doing) then there is functionally no difference between the impact of leaving funds in the reserve accounts as opposed to issuing debt and transferring the funds to the ‘outstanding debt account’.

This also means that traditional open market operations, where the central bank buys and sells public debt to the non-government sector in order to drain or add reserves such that there is an appropriate balance that allows it to maintain its current interest rate target is unnecessary.

Some further points

First, the debt issuance does not fund the net public spending. It just gives the non-government sector an alternative financial asset in which to store its overall saving.

The net spending would occur without the debt being issued.

Second, the funds used by the non-government second to purchase the debt came from past fiscal deficits that had not been taxed away.

Third, if the government was concerned about the interest rate (yield) it was paying on the debt it issues, then the central bank” can always control that yield through appropriate purchases of that debt itself, which influence the price of the assets in the market and thus the yields.

This changes the interest paid by government from the market yield of the debt purchased to the rate paid by the central bank on reserve balances.

Fourth, the central bank can always purchase any debt that the private sector chooses not to purchase via the primary auctions. There may be legislative or regulative rules that apply here but they are creatures of the government anyway.

The last two observations mean that there is never a reason for government bond yields to rise above a level that the government considers to be acceptable.

Which means that a currency issuing government (which is the consolidation of the Treasury and central bank) can always assume the role of its own largest lender and borrow as much as it likes from itself (subject to laws it itself makes etc).

Fifth, governments always have the option of issuing only short-term debt anyway.

There is a distinction between the interest the government pays and the yields on longer term government bonds, as the government can elect to not sell long-term bonds if it doesn’t want to pay those rates. But it might want long-term bond yields to be lower for other reasons, such as the cost to private borrowers for home mortgages.

But even in that instance, the government can use the banking system to fund those at any rate it elects.

Basic Principle 4: The Price Level story

We define ‘inflation’ as a continuous increase in the price level. A once-off rise in prices in not considered to be an inflationary episode.

In MMT, given the currency is a state monopoly, the state becomes the ‘price setter’ because the price level is necessarily a function of the prices paid by government when it spends or the collateral demanded when it lends.

This ties in with the Job Guarantee as a macroeconomic stabilisation framework within MMT. As the government is offering jobs at a fixed price to anyone with a zero bid for their services in the ‘market’, that spending becomes a price anchor.

A continuous increase in the price level will not be the case unless the state keeps bidding for goods and services in the market at the continuously higher prices.

All spending in the economy carries an inflation risk if it tries to compete on a continuous basis for real resources that are currently fully utilised.

We need to understand that a once-off increase in government (or non-government) spending will typically not generate an inflationary episode.

The price level might rise as mark-ups are applied to the higher costs but such an impact is finite.

Typically, there are spare resources available for purchase, and, as such, the inflation risk is low.

But history tells us that this is not necessarily the case. There are well-documented examples where unemployment has been high and there is a concomitantly high inflation rate. Venezuela and Turkey are current examples. The stagflation that beset the West after the OPEC oil price rises in the 1970s is another example.

We understand those examples, within MMT, by realising that, ultimately, the inflation continues because the government paying more for the same ‘basket’ of goods and services, through various means such as indexation policies.

But it should be understood that the ultimate constraint on government spending is not financial but real, the actual resources that are available for sale.

Principle 5: The fiscal sustainability and fiscal space story

In the mainstream macroeconomics, the concept of fiscal sustainability and fiscal space is defined in financial terms.

For example, the IMF defines fiscal space in this way:

“the room in a government’s budget that allows it to provide resources for a desired purpose without jeopardizing the sustainability of its financial position or the stability of the economy. The idea is that fiscal space must exist or be created if extra resources are to be made available for worthwhile government spending. A government can create fiscal space by raising taxes, securing outside grants, cutting lower priority expenditure, borrowing resources (from citizens or foreign lenders), or borrowing from the banking system (and thereby expanding the money supply). But it must do this without compromising macroeconomic stability and fiscal sustainability, making sure that it has the capacity in the short term and the longer term to finance its desired expenditure programs as well as to service its debt”

MMT rejects these notions outright.

You cannot define fiscal space or sustainability by some given deficit size relative to GDP or some threshold level of public debt to GDP or any other self-referencing ‘financial’ ratio.

The concept of fiscal sustainability cannot be meaningfully defined in terms of any notion of public solvency. A sovereign government is always solvent (unless it chooses for political reasons not to be!).

The concept of fiscal sustainability will not include any notion of financing imperatives that a sovereign government faces nor invoke the fallacious analogy between a household and the government.

The concept of fiscal sustainability will not include any notion of foreign ‘financing’ limits or worries about foreign ownership of a sovereign government’s debt.

We have learned that:

– a sovereign government is not revenue-constrained, which means that fiscal space cannot be defined in financial terms, the capacity of the sovereign government to mobilise resources depends only on the real resources available to the nation.

But, saying a government can always credit bank accounts and add to bank reserves whenever it sees fit doesn’t mean it should be spending without regard to what the spending is aimed at achieving.

The concept of fiscal sustainability is more appropriately defined in terms of societal goals such as well-being.

For example, fiscal sustainability is directly related to the extent to which labour resources are utilised in the economy.

The goal is to sustain full employment, which is the base case in an efficient economy that seeks to avoid resource wastage.

Once the government assumes its responsibility to achieve and sustain full employment there are specific requirements imposed on its spending:

1. A macroeconomy is in a steady-state (that is, at rest or in equilibrium) when the sum of the spending injections equal the sum of the spending leakages. Whenever this relationship is disturbed (for example, by a change in the level of injections, however sourced), national income adjusts and brings the income-sensitive spending leakages into line with the new level of injections. At that point the system is at rest again.

It should be understood though that the system is in constant flux and equilibrium defined in this way is being continually disturbed. The resulting income changes work to bring the injections and leakages back into balance.

2. The injections come from export spending, investment spending (capital formation) and government spending.

3. The leakages are household saving, taxation and import spending.

4. For every ’agent’ that spends more than their income, another ‘agent’ necessarily spends less than their income.

Any government, corporation, resident or non-resident can run deficits (spending more than they earn). For example, those who spend more than their incomes include households borrowing to purchase houses, businesses borrowing to invest in new capital equipment, and governments that spend more than they extract in taxes. On the other side, households and businesses that save are running surpluses.

5. An economy at rest is not necessarily one that coincides with full employment or has all desired savings realised.

6. When an economy is ‘at rest’ and there is high unemployment there must be a spending gap and unmet saving desires given that mass unemployment is the result of deficient demand (in relation to the spending required to provide enough jobs overall).

7. If there is no dynamic which would lead to an increase in private (or non-government) spending then the only way the economy will increase its level of activity is if there is increased net government spending, this means that the injection via increasing government spending has to more than offset the increased drain (leakage) coming from taxation revenue.

8. To sustain full employment, the fiscal deficit has exactly offset the gap left by non-government leakages being greater than the injections.

If the fiscal deficit is not sufficient, then national income will fall and full employment will be lost. If the government tries to expand the fiscal deficit beyond the full employment limit, then nominal spending will outstrip the capacity of the economy to respond by increasing real output and while income will rise it will be all due to price effects (that is, inflation would occur).

In some cases, a fiscal surplus will be required to sustain full employment without inflation should the non-government injections outstrip the leakages (say if the export sector is particularly strong).

A government operating according to those rules is conducting a sustainable fiscal policy.

The fiscal balance that arises under those conditions is whatever it is.

There is nothing intrinsically good or bad about a fiscal deficit of 2 per cent of GDP, compared to a deficit of 10 per cent of GDP or a fiscal surplus of 3 per cent of GDP.

Assessing fiscal sustainability requires us to understand the context, which means we have to understand the saving and spending decisions of the non-government sector.

This also ties in with the MMT concept of fiscal space, which is about unmet savings desires as evidenced by the existence of mass unemployment.

In a modern monetary economy, fiscal space has nothing to do with what the current fiscal balance is or has been and what the current public debt ratio is or has been.

A sovereign government can purchase any idle resources that are for sale in its own currency, including all idle labour.

The available resources (goods and services) that are for sale in the currency of issue defines how much fiscal space the government has.

Such a government can never run out of funds in pursuing its goal to ensure all available resources are being productively deployed.

So a past deficit poses no particular constraints on what the government can do in the future, except to say that if the deficit has been properly calibrated to sustain full-employment then there will be less to do should the private sector contract.

Basic Principle 6: The currency sovereignty story

To finish the discussion we can now clarify the MMT meaning of currency sovereignty.

Some people seem to think that monetary sovereignty is about being able to buy everything a nation might need to be prosperous.

I note that Warren prefers not to use the term ‘sovereignty’ because in his view it leads to confusions such as the statement in the preceding sentence.

I prefer to use the designation however.

In common parlance, the term relates to the power of the government. But what I think MMT shows is that there is a sharp difference in the capacity of a government has ‘monetary sovereignty’ (defined below) and one that does not.

The Eurozone governments are ‘sovereign’ in the common parlance but not in the MMT parlance because they use a foreign currency.

That is why I prefer to use the term. However, Warren and I agree on the substance that follows.

In MMT, currency-issuing countries that do not borrow in foreign currencies or peg their currencies by any arrangement are sovereign in that currency.

Such a government, which in MMT represents the base case for conduction monetary and fiscal policy:

1. Spends and taxes in its own currency exclusively.

2. Its central bank sets policy interest rate. The preferred setting is at zero per cent.

4. The currency floats.

5. The Government does not borrow in any foreign currency.

Accordingly, that government can purchase anything that is available for sale in that currency including all idle labour.

As a result no productive resources ever need to be idle if they are looking to be used.

Of course, it does not mean that a country devoid of natural resources or dependent on imports for food and energy will generate prosperity just because its government can ensure all productive resources are working.

If no other nation desires the exports of that sort of country then it remains materially poor regardless of how ‘sustainable’ the government’s fiscal policy is.

Conclusion

This post hopefully will serves as a reference guide in one place to the basic principles of MMT as seen through the eyes of Warren and myself.

More MMT on TPPA = CRISIS

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