One part of my morning today will be to give a seminar on modern monetary theory. It's based on this material, which I wrote last year, and which is worth repeating here:
There is something elegantly simple and radical about what is called modern monetary theory, even if nothing it has to say is modern, theoretical or in some ways much to do with money. What MMT says, as far as I am concerned, is as follows.
First, in a country with a fiat currency, which means that there is no asset backing to the money in circulation, which money does as a result only get value as a consequence of a government's promise to pay, there is, at least in theory, no limit to the amount of money that a government can create.
Second, a government creates money every time it spends because it instructs its central bank to extend it the credit to do so on every such occasion. It is not constrained by the availability of taxation funds when doing so: money can always be created by a bank on demand and at will, and central banks will always do this when instructed to do so by the governments that own them.
Third, to prevent this new money creating excess inflation a government has to tax to withdraw currency from circulation. This is the primary fiscal purpose of taxation, although tax also has other, as significant, purposes as noted below.
Fourth, the government does not need to borrow if it runs a deficit. Firstly that is because it can, at least in theory, simply run an overdraft at its central bank, on which no interest may be charged. This negates the need for borrowing. Second, government borrowing actually makes little apparent economic sense in an economy using the fiat money of the national government because the money that is supposedly borrowed has already been created by the government when injecting cash into the economy through its spending. But, and I stress the point very strongly, that does not mean that a government should not appear to borrow. A government has a social duty to be the borrower of last resort to its population and financial system. That is the function of government borrowing, and it is vital to the efficient operation of any fiat currency using economy.
Fifth, the same social obligation means the government is not indifferent to the way in which taxation is levied, or to non-payment of tax, even if sufficient tax is collected to secure the fiscal balance that it desires. Tax might have a primary goal of controlling inflation, with the secondary advantage that the tax charged for this reason provides the currency with value, but tax also has the other deeply significant social purposes of correcting income and wealth inequality; repricing market failure; delivering fiscal policy by incentivising or penalising certain activities and by reinforcing the social contract that exists between a government and its electorate. Tax is a reflection of the values of the society we live in and is the primary mechanism any government has for reinforcing them. For MMT to be indifferent to taxation is, therefore, completely incorrect. It would also mean that MMT was indifferent to the distribution of impact of taxation, both nationally and internationally, and I cannot accept that this is its intention.
Sixth, the fact that the government spends first, and taxes second, means that the answer to the question 'how are you going to pay for it?' is always available to anybody who understands this process. A government decision can always be paid for, presuming the actual resources required to deliver it exist within the economy, simply by commanding the central bank to pay for it and then arranging, if necessary, for the additional tax due on the income that has been generated (because all government expenditure is, by definition, somebody else's income) to be collected.
Seventh, the realisation that a government that only borrows in its own currency cannot, as a result of this understanding, ever default on its own debt because it can always issue the instruction to its central bank that the payment of that debt be settled, is also of considerable advantage. Such a government should never be beholden to financial markets if they do not overheat their economies.
And that's it. That is modern monetary theory in a nutshell. In essence: the sectoral balances balance. Government debt is private wealth. If you want government created money the government has to run a deficit. There is nothing to worry about in this policy so as long as the economy is not overheated as a result. And the art is not over-heating. But the risk of doing that is much smaller than the risk from putting the economy in the fridge to avoid the chance of doing so. This is a universal truth wherever the conditions for the use of MMT understanding apply.
By saying so I make clear a great many other things. The first is that modern monetary theory does not apply, and cannot be used, when the government does not have a fiat currency, or has to borrow in the currency of another country, or lets the currency of another country be used in common circulation within its economy; then the preconditions for modern monetary theory to work do not exist. There is no point pretending that they do when they do not. A failing tax system also prevents MMT functioning in practice.
Second, modern monetary theory does not eliminate exchange rate risk. It still exists. That is in large part because most exchange rate risk has nothing whatsoever to do with government economic action. It is created by political risk, as has been the case with the substantial down-rating of sterling since the Brexit referendum took place; or it is created by external price shocks, as for example are commonplace with regard to energy and other raw material prices; or it can arise because of short-term speculation, which is only sustainable if economic fundamentals of the type previously noted have changed. But, and I do make this clear, if a government that thinks it believes in modern monetary theory believes as a consequence that it can create money without limit, then it is fundamentally wrong. Likewise, if it thinks it can spend without taking into consideration the limit of available resources within the economy itself and ignores entirely the impact upon imports then the use of MMT can, and usually will, have a downward impact upon the balance of payments and the long-term value of the currency. This may not be a problem if the process of change is gradual: many economies have and will sustain themselves despite such long-term declines in value, but it is pointless to pretend that the risk does not exist.
Third, there is absolutely no necessary relationship between modern monetary theory and a jobs guarantee, or any other left of centre economic policy come to that. They are, in my opinion, completely unrelated, even if it is obvious that modern monetary theory does permit the government to pursue a policy of full employment at fair wages if that is its wish. But the last words are critical: this may not be a government's wish, although few parties are honest enough to say so. To presume MMT requires a left-wing agenda is just wrong: it is a description of actions, not an agenda for left-wing governments, albeit that it can usefully inform the decision making of those who want such a thing.
Fourth, there is also no relationship between modern monetary theory and anti-neoliberalism. Modern monetary theory is not a theory or a philosophy, which is why it was so badly named. It is simply a description of a process that, as a matter of fact, happens, even if that is not widely appreciated. In that case there is no conflict between modern monetary theory and neoliberalism and the neoliberal could, in my opinion, as readily prescribe to this idea as anyone of left of centre persuasion.
Fifth, there is also no link whatsoever between modern monetary theory and Brexit. If you believe in MMT you do not have to want out of the European Union. The simple fact is that there are far more factors to consider when discussing such a complex issue than how the government funding cycle works (which is what MMT addresses). It's true that some aspects of EU policy appear antagonistic to MMT, but as quantitative easing showed, most things can be worked around where there is the political will to do so within the EU.
And that's pretty much all that most people really need to be known to be across MMT.
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I’ve watched a few Keiser Reports lately. ( bit too chilly to do the garden )
It seems some people still think gold is desirable as a backing for money.
Max is not a reliable source of opinion, in my opinion
Good to have a drink with (I have)
But not much more
I have come to the same view.
Stacey Herbert seems to share his views but she does come up with some interesting quotes.
I think they share a lot
They are in a relationship…..
Thank you for this.
So I think this implies the percentage of our national debt which is owned by the BOE does not need to be paid back by extracting money from the private and corporate sector – only if economy is overheating and the reason for the extraction is to slow economy not primarily to reduce BOE debt.
What are purpose of National Bonds in this theory, which need to be paid back allbeit with money creation if necessary?
Lastly does this mean austerity for most vulnerable is an ideology not a necessity and if the former why do the opposition find it so hard to articulate this in a coherent way?
Lots of questions rather than a comment, if busy please do not feel obliged to reply.
A) QE bonds will never be returned to the market in total if ever much at all
B) Search this blog for why we need bonds or gilts – I have addressed this several times
C) Austerity was a choice and wholly unnecessary
All well and good but I also follow Paul Krugman on Twitter and note that he scoffs at MMT, so it would be interesting to see some comment on prominent objections.
And what of the argument that most money is created by private banks not the central bank? This was drawn to my attention lately: https://www.sciencedirect.com/science/article/pii/S1057521914001070
Implications?
You could say this blog is a response to Krugman, who looks rather silly on this
And banks only create money under licence from the government
And it is government backed money, not their own, that they create
“banks only create money under licence from the government” is a rather mealy-mouthed way of describing the outrageous privilege the commercial banks actually possess.
Can I suggest you catch up with Steve Keen, for example in his latest posting
https://www.patreon.com/posts/brief-history-of-26612065
This makes it clear that governments choose to exercise very little constraint on bank lending. The result is that, overwhelmingly, our money is created as interest-bearing debt.
Wolf on the FT, even the BoE itself ‘gets it’. Sovereign money issued by the State interest free is possible, but insignificant.
That’s a choice
It does not change the fact
The description is right
I agree with Steve
I like Paul Krugman but he is American and their central bank is not nationalised like ours or ran along the same lines.
Krugman’s appeals to the Fed – and some are very well argued and for the right reasons (giving an economic uplift to main street for example) – really just come across as ‘begging-bowl’ initiatives at the end of the day because we know that the financial establishment in the USA are in it for themselves and have no interests other than their own at heart.
For all his talent and humanity, Krugman to me is so typically a modern liberal – too active at calling out the issues but far too conservative (neo-liberal even) when trying to put forward answers.
In fact – what answers?
It’s a shame because he does care.
The Fed functions like the BoE even if not state owned
Except more so
It issues THE reserve currency
The commercial banks are simply acting as licensed agents of the State. That is why you can’t just set up your own bank and start running it out of your back room. So as agents the banks also have to be strictly controlled and regulated, which is where we fall down. And they should not really be allowed mega-bucks salaries as when you are licensed to create money it is hardly difficult to end up with lots of it! I think it was Warren (Mosler) last night who said ‘You would not issue live bullets and missiles to new cadets in the army as they have to be trained and disciplined first. So why would you issue a license to create money to banks without ensuring they are tightly regulated and controlled? Banks are dangerous things.’
He also said the best way to do that was to specify what banks were allowed to do, rather than to say what they are not allowed to do (which they will always find a war around).
There are also a number of detailed deconstructions of Krugman’s views on MMT. Here are just two of them –
https://www.bloomberg.com/opinion/articles/2019-03-04/krugman-s-macroeconomics-is-no-match-for-mmt
http://neweconomicperspectives.org/2019/03/three-natural-experiments-documenting-krugmans-bias-against-mmt.html
Thanks
Krugman doesn’t understand money ; its creation and destruction. I’ve come to the conclusion he’s a fake . I think he likes to posit himself as the most reasonable man in the room , seeing any economic issue from all sides and then coming up with his own perfectly reasonable solution. Except that, in order to do so he leaves out human beings , which are messy by nature and do not conform to elegant theories . Money is only money when it is in circulation ( like blood in the body as opposed to blood in a blood bank ) and this ( so far as I can tell ) is the essence of MMT and why it doesn’t see problems like those raised against it by Krugman and others. Once it is in circulation all bets are off and those who have the most clout get to get their hands on more of it . I speak with some experience and not on the downside. Krugman has made himself a nice , tidy pile by taking the stance he does, but it does little to make him worth paying attention to, apropos MMT.
Is it fair to say that JM Keynes would be in broad agreement with MMT?
I would hope so
He disagreed with Lerne on functional finance but he was not living in a fiat currency world
He would agree now, I think
Although ‘MMT’ is increasingly discussed and critiqued, which ofc is a good thing, it’s essential to keep reiterating the basics until the point is reached when it has become the accepted macro-economic wisdom. There’s still a way to go. So thanks for re-posting your previous material.
Before embarking on MMT 101 the pivotal mindset change is to understand that, despite its misleading description, it’s not a theory to be applied in order to achieve policy objectives. It is a description of how a sovereign fiat-based monetary system actually functions. Apologies for stating the obvious … except that apparently it’s not that obvious to people who should know better, as Bill Mitchell explained yesterday : ‘US Congress hypocrites lose the plot’ – http://bilbo.economicoutlook.net/blog/?p=42327. Now whether or not they, and their media cronies, really do understand and choose to denounce MMT for tactical political reasons we may never know. Probably a mix of both – as it is with UK MPs and Treasury officials. One can only hope that, before it’s too late, enough senior politicians in the major economies will be both enlightened and courageous enough to make use of its insights in order to kick-start the urgent changes needed for our future survival, such as a GND.
Nevertheless it’s been really encouraging over the past 5 or so years for me to witness the exponential impact MMT is having across the board – thanks to academics and activists or a combination of both such as yourself. A march of 1000 kms … etc. etc. I hope the seminar was well received 🙂
If I get time I will write up feedback
Biroadky agree with you – and on this one with Bill
Thanks Bob,
Lots of good information in this. I’m very glad you are seeing how when the main stream scoffs at MMT they are misrepresenting it first.
I’d quibble with a three things.
1
I’m not sure the economy needs a “borrower of last resort”. If the government decides the natural interest rate is zero (as MMTers claim it is), it can offer to borrow at zero and who would accept? I mean what would be the point of lending to the government at zero? Oh… maybe the reason is that the government is acting as the bank. The “borrowing” is simply holding your currency in some deposit account. Of course if the government wants a non-zero interest rate it will need to enforce that rate by borrowing at that rate at whatever quantity the market desires.
2
I understand fixed currencies to also be MMT currencies. They would be situations where a government is “not sovereign” in its currency. As I see it, there is a continuum between the US level of sovereignty and EU countries. There are MMT economists analyzing how countries including North African countries need to deal with their dependence on food and/or energy imports to gain sovereignty.
3
About the Job Guarantee. It sounds like your thinking is close to mine as far as whether or not it is part of MMT or just ideological. I’ve rationalized my way into agreeing with progressives on this. (full disclosure: I am probably a progressive) I did this when I realized that buffer stocks are very important to MMT. The government’s ability to create its currency in whatever quantity allows it a huge amount of control over the market that uses the currency. Combine that with Mosler’s “Parable of Turning Trash into Money” and you realize how the government has damaged us with the imposition of tax liabilities. It is a very small step from there to conclude that any good government has a responsibility to minimize or eliminate that damage somehow. And then that the Employer of Last Resort is the clear obvious strategy to do so immediately, while probably also making other policy changes to reduce the need for that program.
Thanks again for your effort figuring MMT out.
A) In reality the propensity if banks to fail requires a borrower of last resort
B) I disagree: I do nit think your claim is right
C) Tax does not cause harm. Unless you define all the social and economic goods that flow from it as harm. I don’t
Full employment with price stability can’t be achieved without a buffer stock of employed people who are paid a living wage. There needs to be a price anchor in a monetary economy. At present we use a buffer stock of unemployed people as a price anchor. This is cruel and inhumane and economically wasteful. It is objectively superior for the price anchor to be a buffer stock of employed people who are paid a living wage and doing jobs that are socially valuable, environmentally sustainable, meaningful, and suited to the abilities and interests of the worker. That’s why a Job Guarantee is a core feature of an MMT-informed economic policy. It is not an optional extra. Price stability is very important.
Nicholas, claims of a job guarantee being intrinsic to MMT are factually incorrect however you want to spin it. For example it could be replaced with a full livable basic income for a variety of reasons a concept I find superior to the job guarantee.
I really wish people would stop conflating descriptions of reality with their favoured solutions. The first part is factual and the second optional.
An excellent and clear exposition (as usual.) But I have one quibble when you say:
“It is simply a description of a process that, as a matter of fact, happens, even if that is not widely appreciated. In that case there is no conflict between modern monetary theory and neoliberalism.”
I believe that Neo-classical economics fundamentally disagrees with MMT about how money is created and (like Krugman) limits Banks to simply mediating between borrowers and savers. Also that Central Banks can control the money supply by manipulating the base rate. Both of which MMT shows are untrue.
I think you are saying the economy is like a machine and all MMT does is accurately describe how the machine works. But the operator of the machine can still choose to do what he likes. So a socialist may do one thing but a neoliberal would still be free to do the opposite. That is true as far as it goes. But neoliberals do tend to espouse neo-classical economics because it serves their purpose. The critical difference to me is the old ‘Private good/public bad’ belief. They think that neo-classsical economics ‘proves’ that adage to be true – that what is good for private profit automatically best serves the public good too.
So I think there is a fundamental problem for neoliberals with MMT. If they accept MMT they have to abandon that core belief. Or if not abandon it at least confront the reality that it must be proved again using MMT. Which would be difficult. MMT does bring the role of government and the issue of public purpose into clearer focus. Neoliberals would prefer that not to happen. But public purpose needs to be clearly addressed when driving this machine. It should not be simply the whim of the driver (or the lobbyists in the back seat.)
OK – fair enough and yes you are right – the Fed has been more proactive but I see this in the context of US protectionism anyway and also helping to keep the dollar value high given the huge amount of supposed debt it has on its books (I’m thinking here of the market’s orthodox reaction to that – not mine). But I was thinking about why Krugman might be so dismissive of MMT maybe to do with whatever was the culture at the Fed who allowed an $800 billion bail out of the banks?
How often have we heard about ‘main street’ needing a bail out as opposed to ‘Wall Street’?
MMT (and its specific targeting of sector of the economy?) would answer that question for the American people.
“……there is also no link whatsoever between modern monetary theory and Brexit.” ???
MMT is about macroeconomic theory. Brexit is mainly about a failure of macroeconomic practice, both in the UK and in the wider EU.
Brexit isn’t just about net migration. However, even that has macroeconomic causes. People don’t choose to move to Manchester from Malaga for better weather!
Are you sure Brexit us about macro failure?
Micro I buy
Macro as grossed up micro maybe
But true macro?
And is it really all that?
You’re absolutely correct about modern monetary theory being a totally regrettable misnomer. It’s simply the framework for rational economic policy with a fiat currency that has been increasingly and increasingly widely accessible since Nixon abandoned US Dollar convertibility in 1971. The opposition to the effective use of this framework has been ferocious and sustained. Without indulging in conspiracy theories, the visceral opposition of the 1%, of the politicians and polices makers they have suborned and of the armies of professional flunkies and functionaries who service them is perfectly understandable.
The wealthy and powerful simply wish to restrict, suppress and control the ability of elected governments to pursue policies using their spending and taxing powers that benefit the vast majoirty of their citizens as it damages their ability to massively increase their power, influence and wealth. The empowerment of allegedly independent central banks is a key element of this. Hayek and Friedman provided the intellectual foundations, followed by an army of well-rewarded academic and think-tank camp-followers. And the false household analogy resonates deeply and widely even among those with little stake in the effort.
But, and this a big but, elected governments and parliaments are not always founts of wisdom. Deficit bias and an unwillingness or inability to use fiscal instruments in a timely and targeted manner to stabilise economies are part of the reality. And workers can often undermine their interests. For example, trades unions in Britain behaved particulalry stupidly during the 1970s. In addition, reactionary, xenophobic nationalism and aspects of fascism are never far from the surface.
We can never assume that good people with the public interest at heart will always triumph in the democratic contest. The ability to throw out the bad ‘uns after four to five years is some protection, but not a failsafe. And, aye, there’s the rub.
Macro-economics…
Most western societies use fiat currency – fiat means that the value of your currency isn’t based on a fixed asset like gold, it is based on what the currency-issuer predicts will be returned in taxes. It was Nixon who did away with the gold standard, and created fiat currency, and he initially pegged the value to employment, or the labor market, but then made a deal with Saudi Arabia so the value of the dollar, internationally, was tied to oil.
So, the value of any fiat currency can be based on any asset, including, and possibly most productively, employment, but also natural resources.
The currency-issuer is the government, and it controls how much money it produces via a central bank. To ensure there is not excessive inflation, the government and central bank should regulate the issuing of currency based on realistic returns.
The government does not collect taxes before it spends money, it spends first, then collects taxes. Austerity is harmful to the (macro) economy, because it intevitably reduces its potential income. Investment in infrastructure is a good way to create jobs and keep businesses running, and ensure good tax returns, and it theoretically could improve society and /or the environment. If a government does not invest in its country then the economy will shrink.
The government creates money first then collects that money back through taxes. The money it receives back will vary, and so the money it issues will vary. When people and business save money, keep it in a savings account for instance, that money is out of circulation and the government is in deficit. The bank that holds this money has an account with the central bank, and so the asset is recorded, but the government will not use this – so this money exists in the system, but the government has received less money back than it issued, hence a deficit for the government is good for private business and citizens in monetary wealth terms. When a government is in surplus, it is getting back more than it issued. These short term trends need to be balanced by either policy decisions or issuing more currency, that is, spending more while in surplus or issuing more money while in deficit, so they are not wildly varying. Balance.
There is no reason for a government to borrow money, it can produce more money within limits of the resources of the country, and it can create resources by investment.
International matters…
A country generally trades with other countries, exporting excess goods, and importing needed goods. Exporting more than you import will drain resources, and importing more than you export will increase resources. This includes money.
——
I’ve excluded lots of question marks in the above, I am just practicing simplifying an explanation of a country’s economy – and by doing that trying to expose any misunderstandings I have – and so am using you as a sounding board (if you are so inclined to spend the time reading! Busy as you always are). What strikes me if that ‘good governance’ is at the heart of this – that the political will and understanding are necessary. Separating out macro economics from politics is not really possible? I think a basic message can be put across, as a concept, without detail, which gives a grounding on which people can base further detailed learning on – that is, don’t confuse the initial concept with jargon and smaller matters that don’t affect the broad scope of the mechanism. Then move on to ‘but what about my pension/mortgage/villa in the Algarve/bonds/inflation/rates/etc,,,’. Maybe?
Many thanks for the simple description. You mention the risk of a failing tax system. What does that look like?
A system where evasion is rampant is what I was essentially referring to
Oh dear. That sounds like the UK tax system to me.
Relatively we are in good shape compared to most
Could be much better
But still better than most
Is it still the BofE the govt instructs to extend credit/create money for it? I thought that had stopped due to the arrangement with the Ways & Means account being frowned upon by the EU, and that the DMO handles that now in some EU-friendly manner. That’s part of the Treasury though, not the BofE. How does it work now?
I was writing generically
The detail is just that
Admin in other words
Thanks for the refresher Richard. After watching Billionaire Ray Dalio on 60 Minutes, and reading his recent essays, I think he has moved much closer to your views than one would expect from Investment Banker:
https://www.cbsnews.com/news/ray-dalio-capitalism-needs-reform-wealth-inequality-is-a-national-emergency-60-minutes/
His April post explains why inequality is a national emergency with ‘inevitable’ consequences- https://www.linkedin.com/pulse/why-how-capitalism-needs-reformed-parts-1-2-ray-dalio/
His May post explains that we need to fix the monetary system to meet the funding and inevitable debt crises from increasing the money supply through debt . https://www.linkedin.com/pulse/its-time-look-more-carefully-monetary-policy-3-mp3-modern-ray-dalio/
His move is useful
Perhaps Dalio should joint the Democratic Presidential Race !
Alastair, MMT economists themselves describe the Job Guarantee as an integral feature of the MMT framework because a buffer stock of employed people who are doing socially valuable and ecologically sustainable and skill-enhancing work and who are attractive to mainstream employers is a better price stabiliser than a buffer stock of unemployed people.
A UBI has no price stabilising properties whatsoever because it decouples income from production and it is not counter cyclical.
But MMT has a price stabilising property – tax – and so the claim for JG is not unique or central to MMT. tax is
Tax as a withdrawal or injection, depending on increase or decrease is central to all economics not just MMT!!!
No one argues otherwise
But then, MMT is what actually happens
So that’s hardly surprising
It’s just MMT remakes the point when the world has forgotten it
And that’s pretty important
So MMT theory is understood by the mainstream and isn’t new. I think that needs to be seen by those who are “enlightened” and see it as a whole new way forward. It isn’t..
Where you and the mainstream disagree is on the constraints of a fiat currency both inflationary and the impact on the currency. You believe inflation can be controlled by taxation otherwise will argue increasing taxes in an inflationary environment 1) won’t be achievable at the ballot box and 2) inflation and inflationary expectations isn’t a tap that can be easily controlled 3) the danger a populist government will over promise and over spend and we will revert to a traditional boom bust … so these are the discussions which should be happening
You wholly miss the point(s)
First, if what you said was true then the mainstream would not be horrified by MMT, but it is
Second, you miss the point that the mainstream is dedicated to neoclassical monetary policy and MMT is about fiscal policy devoted to full employment
As such you miss the point that MMT is new in the modern era, because it challenges the hegemony of economic thinking in ways that disrupt power as it is
And then you make clear that what you are happy with is keeping people on low income and even unemployed to preserve the value of the wealth of a few
And MMT challenges that view
And you think I should agree with you that this is the right objective of economics?
You have another think coming
But at least you exposed your rather nasty true colours
Now go away and play with Nigel Farage: he’ll like what you have to say
“And then you make clear that what you are happy with is keeping people on low income and even unemployed to preserve the value of the wealth of a few”
Err.. where did I say that???
MMT as you discuss is indeed fiscal Keynesianism, nothing new. I haven’t actually disagreed with anything!!! I have outlined the constraints of fiscal policy/ Keynesianism or MMT or however you want to dress it up. And these are the debating points..not that you have indeed discovered some new facet of economics.
With respect, you’re rather like a climate change denier saying we’ve always known there are temperature variations, so what?
Because this time it makes a difference
That’s what the ‘so what’ is of MMT
And like climate change deniers I ask why they want nothing to change
And no doubt it’s because what’s happening right now suits you very well
And knowing that is what makes me a political economist
[…] Cross-posted from Tax Research UK […]