I have said what follows before on this blog, but some things bear repetition. And given that I am speaking about modern monetary theory (MMT) to what I gather is quite a large audience tonight this note might be a useful summary that can be shared with participants. As such, I make no apology for summarising what I think MMT says, again:
What MMT says is as follows.
First, in a country with a fiat currency, which means that there is no asset backing (like gold) to the money in circulation, which means that the country's money does as a result only get its value solely as a consequence of its government's promise to pay, there is, at least in theory, no limit to the amount of money that a government can create. It's important to note that every major currency in the world has been a fiat currency since 1971.
Second, a government creates money every time it spends because whenever it decides to do so it instructs its central bank to extend it the credit that makes this possible. 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, like the Bank of England, 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, also significant, social purposes as well, as noted below. To be clear, when interest rates cannot be used to control inflation, as is the case in almost every developed country now (and many others as well) because official interest rates are at, or near zero, tax is the only tool available for this task. MMT is the only current school of economic thought that properly recognises this fact.
Fourth, the government does not need to borrow if it runs a deficit. Firstly that is because it can, as has now been agreed by the UK government and the Bank of England, simply run an overdraft at its central bank on which no interest may be charged. This negates the need for borrowing, whilst, second, government borrowing actually makes little economic sense in an economy using the fiat money of the national government because the money that is supposedly borrowed by the government has already been created by the very same government when injecting cash into the economy through its spending. The term borrowing is, then, a misnomer in that case. What instead a government does by supposedly borrowing is to provide a social and economic service as the depositor of last resort for the savings of its population and financial system, offering a form of security for funds that no one else can. That is the real function of government borrowing, and that savings facility is vital to the efficient operation of any fiat currency using economy.
Fifth, a government that recognises the significance of MMT is not indifferent to the way in which tax is levied, or to the non-payment of tax, even if sufficient tax is collected to secure the fiscal balance that it desires to control inflation. Tax might have that 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. MMT cannot then be indifferent to tax and to claim that it might be is, therefore, completely incorrect. To be so would also mean that MMT was indifferent to the distributional impact of taxation, both nationally and internationally, and that is clearly not 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 because they cannot hold a government that has the power to ignore them to ransom.
And that's it. That is modern monetary theory in a nutshell. In essence, government can and does create money. Government debt is just a means for saving private wealth. If you want government created money (and you do) 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 in not over-heating. Tax can stop that over-heating. And the risk of over-heating is, anyway, much smaller than the risk from putting the economy in the fridge to avoid the chance of it doing so.
Some other things do, however, need to be made clear.
The first is that modern monetary theory does not fully apply, and cannot be as a result usually be used in the way described, when a 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 necessarily exist. There is no point pretending that they do when they do not. A failing tax system also prevents MMT functioning in practice because the means to control inflation does not exist.
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 if a government that thinks it believes in modern monetary theory then 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 this too is wrong as such a policy will have a downward impact upon the balance of payments and the long-term value of the currency. That is precisely why MMT does not prescribe spending without limit or money creation without limit: it has never done any such thing. It does instead pay a lot of attention to the control of inflation. That said, it also suggests that all exchange rates should float, because that manages the exchange risks that no government can control with monetary or fiscal policy.
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. MMT describes how the economy works. But if it is assumed that the object of managing the economy is the creation of full employment then these issues are related in the sense that 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. In that sense the job guarantee and MMT are intimately related, and are logical partners in the process of managing the economy to fulfil the needs of society, but this does not, of course, prevent there being the provision of other aspects to a social safety net. Nor does this link prevent a government that does not want to deliver full employment using the ideas implicit in MMT; it will just simply need to be held to account for why it would wish to choose unemployment as a policy option rather than full employment.
In summary, MMT is the best currently available description of how to manage an economy to deliver full employment. That is its merit.
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“There is nothing to worry about in this policy”
Well I beg to differ. We want a system where difficult choices don’t exist, but realistically we want a system where difficult choices are fewer. That can be achieved by letting the public allocate more of a society’s economic resources. Getting government to allocate more resources still means someone in government has to make hard choices. Winter fuel allowances, free tv licences, free bus passes or free new technology jumpers, free netflix and free green personal transportation. Insulating existing homes with Australian style programmes or making it easier to build new energy efficient homes. MMT doesn’t help you decide which is the best allocation of resources. And it could make things worse if the spenders are irresponsible and politicised.
Oh yes, leaving it all to the market works so well, doesn’t it?
Are you really daft enough to believe that, despite all the evidence to the contrary?
Have you not noticed that the market only makes one choice – and that is shovel money upwards?
And if you haven’t, wy not take off the blinkers?
I am nit sayi8ng. no markets – far from it
But unless the state sets the rules the outcomes are profoundly damaging – not least to markets themselves
Richard, congratulations !
I was just thinking of the overton window as I was reading your blog
I had to look up the definition to remind me but Lo
Is MMT starting to come into the mainstream of the range of politically acceptable policies which we can all take on board ?
With the changes the pandemic & Brexit have brought about in our lives this year
Are we all ready to embrace the logic of MMT
Good luck for tonight
I hope this is an idea whose time has come
I thought of the Overton Window last week when Kay Burley on Sky was interviewing Anneliese Dodds, the Shadow Chancellor. Kay Burley’s intervention, several times, was, ‘but it’s got to be paid back’, and ‘would you cut or tax more?’
Viewers who don’t know about quantitive easing don’t know about the wider context of any discussion on the deficit. TV commentators may mention these things in passing but the casual viewer would be lucky to see any discussion of that wider context.
Yet it is a discussion that, with variations, we have often seen in the last 100 years. The 1930s saw the government try to restore the economy by lowering spending. The history of our country in that time has been one of the City taking precedence over industry and commerce.
You haven’t said what Dodds’ reply to this ignorant question was.
LARRY
all I can recall is her saying that public sector workers should not have their salaries frozen as their spending is someone else’s income.
Shows some knowledge of Keynes.
I am not sure I follow
What I mean is that she knows that cutting state spending by refusing state employee salary rises, will also cut the income of the economy compared to what it would be if they had received the increase. Unlike the 1930s when the govt. cut teachers’ pay 10% and tried the same for the armed forces, provoking the Invergordon Mutiny
https://www.google.com/search?q=invergordon+mutiny&rlz=1C5CHFA_enGB714GB714&oq=Invergordon+&aqs=chrome.2.69i57j46j0j46i175i199l3j0.8188j0j7&sourceid=chrome&ie=UTF-8
A very good nutshell description of what MMT is about.
I’d possibly put it that tax was more about creating a demand for the currency rather than removing it from circulation per se. It’s the demand for the currency which gives it its value rather than the qnty of money in circulation. So a rapidly falling value of the currency, ie too much inflation, could indicate the need to create more demand by way of increased taxation. But I don’t want to sound nit-picky!
Also I fully agree with: “when a 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 necessarily exist.”
This is, of course, the case in the euro using countries. The preconditions don’t exist at all. Where there is some disagreement is in the seriousness of the situation. You optimistically take the view that any flaws can be rectified. Whereas others in the MMT community are more pessimistic and take the view that the blunder in creating the single currency, without a single government to administer it, is so huge that the necessary conditions for the EU to exist as a cohesive political unit have been fatally undermined. Therefore, its demise (in its present form) is just a matter of time.
We will likely see in the next decade who turns out to be right. I hope we can at least agree to disagree on this until then and co-operate to get the essential message across.
I’ll be very slightly nit picky – but I also think you know this, and that’s tax cuts increase demand
And reduced demand reduces inflation
I think your first para needs revising in that case
@ Richard, I meant demand for the currency, to pay taxes, not demand for goods and services. Sorry if that wasn’t clear.
I don’t think there is any real disagreement on this point.
Many thanks, this is really clear.
Thank you for excellent summary and the most important thing everyone needs to remember (when they get confused by the noise):
MMT [simply?] describes how the economy works
Richard Murphy wrote:
“[MMT] also suggests that all exchange rates should float, because that manages the exchange risks that no government can control with monetary or fiscal policy.”
Could you elaborate a bit, for the layperson, how floating exchange rates manage exchange risks?
In the MMT class I am teaching, a resident of Costa Rica asked how MMT would apply to that country. Costa Rica has its own currency but, at least according to Wikipedia, it is not a ‘clean float’ but a ‘crawling peg’. “The exchange rate is now free to float within a currency band referenced to the United States dollar. The floor of the band has been set at a fixed value, while the ceiling changes at a fixed rate. In practice the exchange rate has remained fixed at the lower value of the currency band.”
Under what circumstances would a country be better off with a crawling peg than a clean float (and vice versa)?
If there is a genuine float – in other words, if there is an acceptance that markets will set the exchange rate, which can be occasionally volatile as a consequence – then there will never be an occasion when a government will use its own reserves to support that rate. If those speculating on exchange rates know that this is the case then they will also understand that there is very little chance of making a gain from an attack as a consequence because those arise when the government seeks to protect its rate, and will expand reserves to do so, which reserves are then expropriated by those undertaking a short term attack, particularly if they have very deep pockets that enable them to do so. The classic case was Soros in 1992 when the attack was on sterling. So, a free-float firstly p[revenyts attacks arising and second means that they do not ay and so, thirdly, creates currency stability as a result.
A floating exchange rate prevents attacks on a currency ? And ensures they don’t pay ? And they promote currency stability ?
That might be the most economically illiterate set of statements I have ever seen on this blog. Surely you can’t believe this ? The very opposite is true for each of those statements. Try substituting ‘fixed’ in place of ‘floating’ if you need this explaining
I think we will have to differ
It’s just very odd that no one attacks a currency if it will not be defended with a government’s foreign exchange reserves
Please give me examples otherwise of any consequence
I think you will struggle
@ James,
Sweden also uses a crawling peg – to the euro. It’s hard to keep a currency higher than the market says it should be. This is when the speculators will attack. It’s easier to keep a currency cheaper either with a crawling or fixed peg. Denmark uses a fixed peg. All net exporters manipulate their currency in this way but don’t like to be accused of currency manipulation.
However, once they do this they do have the problem that a surplus in their current account (trade) has to be matched by a deficit in their capital account. So they have to export capital somehow to keep the exchange rate stable. Norway has a “Sovereign Wealth Fund” for this very purpose. Any country allowing a free float has to allow it to go either way. In the case of the USA, Canada, Australia and the UK that usually means running a trade deficit. This in turn means Govt usually has to run a budget deficit to keep spending levels in the economy high.
It’s pity that Govts don’t seem to understand the simple arithmetic of the sectoral balances. Someone in the UK has to do the borrowing to support the current account deficit. The neoliberal “solution” of pushing this on to the private sector has created a whole lot of different problems. Like pricing the younger generation out of the housing market.
PS I should say that Sweden claims to allow a free float. However this is from the Riksbank website. “The gold and foreign currency reserve makes up more than half of the Riksbank’s total assets. This allows the Riksbank to offer emergency liquidity assistance in foreign currency and to influence the krona exchange rate by buying and selling currency.”
There looks to be an awful lot of FX on the Riksbank’s balance sheet. They are more into buying FX than selling it. This looks to be inconsistent with having a supposed freely floating exchange rate.
https://www.riksbank.se/en-gb/statistics/riksbanks-balance-sheet/
Do you not understand that you don’t need to a supply of physical currency to profit from changes in currency rates ? The derivative market is magnitudes larger than the physical amount of currency in issue, and is where the market makes most of its profits.
A lack of physical supply of the currency actually exacerbates moves, rather than preventing them.
This is really very basic stuff Richard and I’m surprised you don’t know this.
I have no idea why you are making this suggestion that is not in any way related to anything that I think
“Second, a government creates money every time it spends because whenever it decides to do so it instructs its central bank to extend it the credit that makes this possible. 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, like the Bank of England, will always do this when instructed to do so by the governments that own them.”
It’s much simpler than this a sovereign government whether democratic or authoritarian has the legal powers to create a country’s currency. What institutions it uses to disseminate currency are defined under the terms of the law set down by the government.
I think William Young is referring to your suggestion:
‘If those speculating on exchange rates know that this is the case then they will also understand that there is very little chance of making a gain from an attack as a consequence because those arise when the government seeks to protect its rate, and will expand reserves to do so, which reserves are then expropriated by those undertaking a short term attack, particularly if they have very deep pockets that enable them to do so.’
The derivative markets offer speculators the chance to profit far in excess of the supply of reserves which would be used to attempt to defend the currency. So it refutes your suggestion that speculators will attack a currency only if they know there are central bank reserves to expropriate.
You miss the whole point: you can only speculate against someone. If the government says it will not defend why speculate? That was my point. This is what I am suggesting is neutered
Richard Murphy wrote:
“[T]here is absolutely no necessary relationship between modern monetary theory and a jobs guarantee, or any other left of centre economic policy come to that.”
This is the sharpest distinction you typically draw between your understanding of MMT and that presented by others, including Bill Mitchell and Warren Mosler — and it is a difference that has troubled me since I started reading this blog.
You go on to write, “MMT describes how the economy works.” To me, this implies a methodological distinction between Description and Prescription — between macroeconomic theory and macroeconomic policy (though both within the scope of political economy). And it implies that a jobs guarantee falls entirely on the Prescription/policy side of the distinction — as the balance of that paragraph confirms.
Mitchell and Mosler might say — I’m paraphrasing and over-simplifying here — that the possibility of the government’s offering a job at a fixed, socially inclusive wage to anyone who wants one flows directly from a monetarily sovereign government’s position as monopoly issuer of the currency. A monopolist gets to set the price of a commodity; the commodity here is labor. In this view, while the Job Guarantee (JG) is a policy, the possibility of a JG is part of the Description/theory side of the distinction.
When presenting MMT and the JG to students and lay people, I have found it useful to replace the methodological dichotomy of ‘Description – Prescription’ with a trichotomy of ‘Description – Inference – Prescription’. This can be framed as a series of three questions: How does the economy work? How can the economy work? How should the economy work? With this framework, we can infer the possibility of a JG in the Inference stage, but it is only when we bring our values to bear in the Prescription stage that we actually develop the JG as a policy recommendation.
Now, I admit that I haven’t worked out all the kinks in how to distinguish between Inference and Prescription, especially when presenting to lay people. But I do think that this approach helps me (at least) to understand the different approaches to a jobs guarantee taken by leading MMT advocates.
I am happy with the description – inference – prescription terminology
It makes a lot of sense
Hi Richard
I really enjoyed your Zoom discussion tonight, though I’m afraid I enjoyed your contribution more than many of the rather extended comments that followed. Most seemed to be disagreeing but I often couldn’t work out how they were disagreeing. So apologies, my mind occasionally drifted, leading me to several thoughts.
1. MMT is actually simple and unarguable (thanks for your latest exposition)
2. Conventional economics has become little more than cherry-picked party-political economics.
3. The sensible offer by MMT of a job guarantee for all will be rejected because this government will never accept the aim of full employment even though it maximises one of the three economic resources (along with technology and material resources). It would give too much power to the employed – and their unions.
4. Likewise this government has no real interest in other social purposes (‘there is no society’ remember), only political purposes, the most important of which is transferring government money to the already wealthy making them powerful enough to control politics to the detriment of the majority in society.
5. There is no discussion of MMT because the government has successfuly sought to control the BBC so that ‘impartiality’ now has clear limits. It wants no discussion of MMT because it undermines unjustifiable austerity policies. especially in the NHS, social care and welfare, and would remove the government’s most effective election strategy, ‘how will it be paid for?’ (Though the government is fair, it also seeks to control the judiciary because of the threat it has shown to pose the government)
6. MMT gets virtually no attention from the rest of the media, not even mockery – a sure sign that they fear that the truth will emerge, even from mockery.
7. Stephanie Kelton’s book really should be entitled, ‘The Deficit Deceit’
Please correct me where’ I’m wrong!
Not much to correct there
Thanks
Counterpoint:
http://neweconomicperspectives.org/2012/05/mmp-blog-50-mmt-without-the-jg-conclusion.html
Is there real demand now (aside from the treasury) for government bonds at tiny interest rates? If the government stop buying up debt will the interest rates paid increase on the open market?
Yes….
Is the answer
Thank you for this latest explanation. I think I understand it all better each time I read it, though I can’t promise I have yet appreciated all the implications.
One consequent question: if governments with their own currency have such a large inbuilt economic advantage, how come we don’t obviously see that in the real world? Or expressed in mundane terms, why doesn’t the German economy appear hobbled compared with Britain’s?
Germany dominates the ECB and eurozone
The euro actuality gives it more power
https://discord.com/channels/676145040845832211/676797264953475073
May I invite you Richard to Neil Wilson’s Discord server
How does that work?
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