I promised a week ago that I would both publish a modern monetary theory (MMT) glossary entry and publish more about what I think MMT is.
11,000 words later this is the first outcome. It is the glossary entry, which summarises the essence of MMT, in my opinion. I am aware that not everyone will agree with it. Comments are welcome.
I will have a lot more to say on MMT as this week progresses.
Modern monetary theory (MMT) describes how governments create money by spending and destroy it by taxation.
MMT suggests that a government spends the currency that it wants to be used to make settlement of the taxes owing to it into the economy with the active assistance and support of its central bank when undertaking its routine spending, for the purposes of which expenditure the central bank provides all the money required by way of loans meaning that neither tax revenues or third party government borrowing are required to fund that spending although they might be for other purposes.
In more detail, it is suggested that the core assumptions of MMT are:
- That a government that has its own central bank and currency, which currency is internationally acceptable, need neither tax nor borrow before spending because its entire government expenditure can be funded by new money creation by its central bank acting on its behalf, with the government then being indebted to its central bank for the sum expended.
- A government that borrows in this way from its own central bank need never repay the debt it owes to its central bank because that debt represents the money supply of the jurisdiction for which it is responsible and that money supply must, therefore, be maintained if the level of economic activity in that jurisdiction is to be sustained.
- The primary role of taxation in the funding cycle of such a government is to control the inflation that might be caused by the excessive creation of new money by that government when fulfilling its expenditure plans.
- The secondary role of tax in the government's funding cycle is to provide the government-created currency of a jurisdiction with value in exchange. That happens because if the tax owing to a government can only be settled using the currency that government creates those transacting in that economy who are likely to have tax liabilities arising as a result will not be able to afford the exchange risk arising from trading in any other currency.
- Once these roles of taxation have been fulfilled the additional role of taxation for a government is as a tool for the delivery of its economic, social, regulatory and inequality agendas. The design of taxes for this purpose is, however, never intended to have a revenue-raising function to enable government expenditure to take place, that expenditure having already been funded by the central bank of the jurisdiction on the government's behalf.
- A government in the situation described need not balance its expenditure and taxation income. In most situations that balance would, in fact, be undesirable. If the government has a growing economy and modest but controlled inflation within that economy, then the expansion of its money supply is essential, and that expansion of the money supply is best delivered by the running of government deficits. Such deficits represent a shortfall of tax receipts compared to government expenditure. This policy should be preferred to increasing the scale of private sector borrowing within the economy, which is the alternative source of new money creation.
- A government in the situation described need never borrow from financial markets. That is because the government can always borrow instead from its own central bank. It has no dependency on financial markets as a consequence.
- A government in the situation described may, however, wish to offer a savings banking facility to those in the jurisdiction for which it is responsible who wish to save in the currency that the government in question has created. It does so in its capacity as a borrower of last resort. This deposit-taking does not represent government borrowing: it is a banking arrangement. Even if the funds deposited with the government are then used to clear the apparent overdraft advanced by the central bank to the government the status of these deposits as a third-party bank or savings facility is not changed: the central bank can always guarantee the repayment of the deposits in question by the creation of new money, which is precisely why the government is able to offer this borrower of last resort facility.
- A government in this position does not need to use interest rates to control inflation. It can instead use the following mechanisms to control:
- Varying tax rates over one or more taxes to tackle the cause of the inflation being suffered. New taxes may be required to assist this process.
- Varying the scale of the deficit.
- Credit controls to limit commercial bank lending.
- A government in this position could seek to run a low effective interest rate policy within its economy to firstly minimise interest obligations to those to whom it provides banking facilities; secondly to provide the best possible environment for investment by lowering the cost of capital; and thirdly to minimise the upward reallocation of resources within the society for which it is responsible as a result of interest paid, thereby reducing inequality, which goals in combination have the best chance of delivering overall economic prosperity.
- A government in this position can have a policy of full employment, knowing that until that point is reached, there will be under-used resources within that economy for which they are responsible, meaning that inflation will not be stimulated as a result so long as the resources put to use are those currently unemployed, whether they be people, physical assets, or intellectual property. This policy could include the provision of a job guarantee for all those seeking work within the economy who are unable to secure it, but any such policy must reflect the individual circumstances of the job seeker and be consistent with the overall delivery of social security within the jurisdiction for which the government is responsible, and cannot as such be a critical component within the economic policy of the government in question.
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Hi Richard.This is great as far as it goes but bear in mind that this glossary could (I hope will) become the first point of reference for inquiring minds. I’ve suggested before that comms and messaging strategy is everything as being correct isn’t sufficient to be persuasive.
To have impact this entry needs the punchline upfront. How about starting with “MMT describes how governments create money by spending and destroy it by taxation. Governments…” That should be front and centre of everything you write about MMT.
Noted
And now done
To me, this is very helpful and Phil C’s suggestion is spot on.
I just wish we had a government that would try this out!!!
Anyhow, you’ve had a superb morning blog wise and could no doubt do with a coffee so I’ve bought you one.
Thank you.
Thanks PSR
There is more to come…
Hi Richard, very interesting. By way of introduction. I’ve read 2 or 3 books on MMT, and have an education in economics.
I don’t understand point 4 very well, or why it would be particularly important.
Could you clarify?
Thanks, Pat
Basically, all it says is that if you have to pay your tax in pounds you won’t pay your staff or trade in dollars because the exchange risk of doing so is too high as every time you trade using anything but pounds you will have to buy pounds to pay the tax (VAT, corporation tax, PAYE) and the exchange risk and hassle is just not worth it. That’s it.
That would be worth adding in as a concrete example for point 4.
Thanks for your reply Richard.
I’ve seen the unit of account for tax (eg sterling) used as an argument for the origins of money, and clearly it relates to the currency sovereignty which is a pre-requisite of MMT, but the argument that exchange rate risk is why employers pay in the national currency seems to me to be a distraction from the main thrust of the argument and probably highly questionable too.
As a more general point, maybe it would be an idea to separate pre-requisites from benefits as per the standard presentation?
However, one of the areas that is rarely addressed is the potential difficulties of MMT and secondly, obstacles to its implementation. Of these it seems to me that the impact on the govt bond market and its role in the economy are critical to the implementation but rarely addressed adequately.
A post on this topic would be much appreciated, cheers.
Why is the exchange risk one not relevant?
Noted re the bond market
Hi Richard.
I wouldn’t necessarily say exchange rate risk is not relevant at all in theory, but in practice I should have thought convenience or even established practice are more likely reasons for employers to pay in the national currency. Surely employers paying wages in a foreign currency are in most cases likely to meet with a lot of resistance in nations with a sovereign currency.
Also even if this exchange rate risk was the reason for not paying in a foreign currency, it would seem in the absence of evidence unlikely that it would occur on a scale large enough to cause problems anyway.
I have on occasion been paid in foreign currencies (ie not the currency of the employing nation), but the countries in question would not satisfy the sovereign currency pre-requisite for MMT anyway.
If there are citeable references to support point 4 it would help, but personally I’ve never seen this argument used in this way before.
Regards, Pat
Pat
My experience is based on discussion in Scotland – where the independence debate makes this a very live issue
Your points are valid, of course
I think exchange rate is the most powerful though
But it is judgement, and I accept that
Richard
You may have covered this. if so please ignore.
I did read there are laws which prohibit a government being able to direct a central bank to create money for them and this is why we had the round about method of quantitative easing -though this was also about re-capitalising the banks after the global financial crisis.
Are these laws domestic or are they part of an international agreement?
Could MMT work without changing the law?
We had agreements, not laws, to do that
Maastricht was one
The US does it openly.
But 15 years on from 2008 we all know that those conventions make no sense any more
MMT is being done now
What need not be done are bond selling and QE
We still pretend we need both
Would a change require new law? No. The government ran an overdraft at the Treasury until 2008 on what was called the Ways and Means Account.
Thanks
that clarified it
The only International Agreement on this subject is the Maastricht Treaty that prevents governments borrowing from their own Central Bank. The (say) German Bundesbank is merely an arm of the ECB so can’t lend to anyone without the ECB “say so”. The ECB statutes also prevent “direct monetary financing” of government spending. However, it does not prohibit buying government bonds (QE)….. which comes to the same thing as allowing governments to “run an overdraft” with the Central Bank. The only qualification is that the purchase cannot not be “direct” but must me in the open market.
Of course, these rules only apply to members of the Single Currency area – not the UK, or Sweden or Denmark.
There is a news story going around at the moment about an economist who tried to pay his taxes to the IRS by using physical cash. This proved rather difficult. The end result is that he receives a physical receipt from the IRS to declare that his taxes have been paid. That is he used the money to clear his debt. And once he paid with cash he has no debt.
Where then does the IRS deposit the physical cash? It is unlikely that it goes to the US treasure because they count the tax receipts of paid taxes. I guess the physical cash is collected by the federal reserve and ends up in the same place as all the other ‘tax payers money’. It is money that has been removed from the monetary system.
Bill Williams
April 17 2023 at 10:20 am
Bill talks about the “IRS”, and it may well be that you can pay tax in cash to the US Internal Revenue Service – I don’t know. Warren talks flippantly about them “throwing it over their shoulder”. You used to be able to pay HMRC in cash – in fact I used to go along to the Inland Revenue office in Oxford Road Bournemouth when it existed to do just that on behalf of a client. You could also pay cash at a Post Office by Girobank. I wish I still had one of those slips and my (probably faulty) memory was that the account number was 0000 0000, which, if true, would be telling. Does anyone have one of those payslips? Nowadays tax can only be paid by bank transfer to an account held by HMRC, whereupon the Treasury periodically “calls up” the contents of the account by way of intsructing the Bank of England to delete the underlying reserves from the holding bank’s Exchange Settlement Account, then crediting the relevant nominal account in their bookkeeping records. As an aside, a proportion of the deposits held by HMRC in an account dedicated to NI receipts are transfered directly to an account held by the NHS, which makes it appear that those NI payments are funding the NHS.
If I understood Warren Mosler’s answer to the question, “what does the US Treasury do with the cash it receives in payment of taxes, fees and fines?” he actually said, “they shred it.”
I’m not sure what is done with coinage.
They could melt it
More usefully, they could recycle it
Which is actually a very good way to think about notes and coins
They are recycled tokens of promises made and fulfilled
If it helps…
This FOI request confirms that HRMC only accepts sterling and what happens to tax after it’s paid:
https://www.whatdotheyknow.com/request/719202/response/1723149/attach/html/3/210211%20Reply%20FOI%20Carnihan.pdf.html
I’ve looked at MMT in the past and to my uneducated eye at least, it seems a beautifully elegant (and simple) approach to the nations finances.
So there must be a catch, otherwise we’d be doing it right?
Let me guess. To many vested interests in keeping the status quo?
Spot on
Surely the secondary role of taxation as you have written is actually the primary role. Without this requirement for currency to pay tax then inflation cannot be controlled via the tax mechanism?
I think the reverse
I am not sure it makes a great deal of difference
I had that problem too. The requirement to pay tax in the currency is surely the crucial property which ensures the currency is widely used for financial transactions in the country, without which most of the features of a currency become meaningless. (That is how it differs from the “digital currencies” like Bitcoin which for that very reason aren’t really currencies at all in the usual sense of the word).
However once taxation has established the functionality of the currency in this way, then the level of taxation has the effect of adjusting the money supply so it isn’t inflationary and it can also be applied in a way to achieve policy objectives such as reducing social inequality.
My other thought about this draft is that it doesn’t distinguish between what is an economic theory (hence the name) and what it implies. That is important because often MMT is criticised not because of its theoretical explanation, but because often people confuse MMT with the political decisions that can be more easily rationalised under MMT (but in the end are political decisions to be taken or not). The obvious example is the concept of Universal Basic Income which is not intrinsic to MMT but can be argued for within the framework of MMT (as you obliquely recognise in point 11) – and creates an irrelevant bogeyman for adherents of conventional economics to attack.
It seems to me that roughly speaking, your items 1-5 are features of MMT, 7-11 are implications for policy, and 6 is a bit of both.
(There is of course a caveat in that what I say is largely based on what I have learned from your previous blogs, although those have prompted me to read and think further including the Stephanie Kelton book).
See this morning’s version when I publish it soon, where I make this distinction much clearer
When you said 11,000 words my heart sank! However, it is a pretty concise summary whilst retaining accuracy.
If I were writing I might do it slightly differently but at each stage where I think I would change something I find that “my take” is in fact included as a subset of what you state…. so, all round excellent.
One amendment is, I suggest, needed. Point 10 should be “could” rather than “would”…. I think it important to distinguish between what MMT (in its minimalist form) IS and what possibilities for policy it opens up.
Amendment made
In the bigger paper (to follow, which is more important than this summary) the distinction you refer to is very clearly made
It is being edited now
Philip is 100% correct above – MMT is not something to be implemented or adopted – it is simply a lens which allows us to see throught the obfuscation and cant of mainstream economics to understand the realities of a fiat monetary system.
A couple of other thoughts: When I first came to MMT many years ago one of the things that really helped me understand were the sectoral balance graphs. Lots of people learn visually and seeing the perfect symmetry they represent can be a lightbulb moment. Link this to a punchy tagline – I really like Stephanie Kelton’s “the government’s red ink is everyone else’s black ink.” Following on from this is that only the government can create new net financial assets in the economy.
MMT also takes the focus away from money and puts it on the available resources. A currency issuing government is never revenue constrained – it can “afford” to purchase anything available for sale in £ or as Keynes said- “Anything we can do, we can afford.” This is one of the other key reasons for a government to tax – to free up resources so it can provision itself without bidding up the price of that resource (thereby creating inflation – a more nuanced explanation of your point 3)
There was a picture/work of art (the giraffe and the parachute or similar) hanging in the Tate that said that it was used to pay an IHT bill – it said so on the picture’s description).
So, for the better off, there is an acceptable option (to HMRC) than cash. Maybe I should get my crayons out and offer to pay my income tax bill in the same manner.
Was it “Zebra and Parachute” by Christopher Wood? https://www.tate.org.uk/art/artworks/wood-zebra-and-parachute-t12038
One of his last works before he committed suicide in 1930 aged just 29. It is unashamedly surreal and modernist, and not to everyone’s taste.
“Acceptance in lieu” seems like a good idea to me – as long as the items are sufficiently important to merit a place, I would rather they are held in a public collection and made available to all, than held privately or sold overseas to pay an inheritance tax bill. It is also rather small beer – a few tens of millions per year. Many galleries and museums would struggle to raise the funds to buy these sorts of things if they came on the market.
“Conditional exemption” – where items are exempted from tax, but kept in private ownership, and become subject to rights of public access which are often quite limited and/or difficult to exercise in practice – is a much more slippery concept.
Agreed
Especially on the latter
Richard, Do you need more than one version of your write-up? I ask because it seems targeted at folks that already get it and it is dealing with complexities from the start (because otherwise you’ll be pulled up for anything that isn’t perfectly correct, I guess?).
Take your introductory paragraph: ” owing to it into the economy with the active assistance and support of its central bank when undertaking its routine spending, for the purposes of which expenditure the central bank provides all the money required by way of loans meaning that neither tax revenues or third party government borrowing are required to fund that spending although they might be for other purposes.”.
You are having to include caveats in order to pre-empt concerns unrelated to the ‘101’ big picture. Much of the required audience has been brought up only by a neo-liberal view of the economy – and that proper economics is just like ‘Maggie running a balanced household budget’. Only last week R4 gave a simplistic overview of ‘how the economy works’. It did say that the nation really isn’t like a household – but it did go along with Taxation is for spending – it didn’t question the reason or alternatives. To me, it seemed that the neo-liberal take on money was simply stated as fact.
“I put it to you, Sir”, that the target for your explanation should not be the many good folk who already read this column – but simplified to help support so many others. That means that an explanation may be best presented in stages. Very simply compare and contrast the ‘basis of money’ – and compare neo-con versus MMT idea or where money comes from. Then introduce the complexities required for more sophisticated models / understanding (we don’t teach kids about relativity till they’ve got the idea of Newtonian physics — there’s a reason for that). For many people, you aren’t just trying to introduce a new concept — you are having to do so in the context of deep rooted misconceptions. That is so much harder. But it also means building up.
Intended to be helpful. Good luck.
and ‘under these circumstances’ So start simple: Something that takes inspiration from the physics academic from Durham explaining public and private money ‘creation’ by banks and central banks, and taxation isn’t to raise.
Let me think about that.
And thank you.
My wife asked for the ledger entries and she is not an accountant.
I am working on diagrams of the money flow. They are not easy.
I could, of course, this through Chart GPT.
Apologies, I left some drafting notes in my submission to you. (I did though really like the diagrams and simple explanations in the Durham Prof’s Econo-Physics post that was linked to last week). Their article was clearer to me academic’s overview papers I’d read before.
I was going to say something similar but actually I think you are nearly there. You’re essentially saying it three times, building up the layers and complexity. The first sentence is the whole thing in a nutshell. The next paragraph is a slightly longer version. And they you launch into a more detailed list.
I wonder if something in a slightly different format might work better for an explanation of “the conventional view of the nation as a household implies … but that is wrong because … whereas MMT implies … which reflects reality because …”
You could say, for example, that there would be constraints on government spending if it adheres to the gold standard. But we haven’t for ages. Or that the public sector does not sit around worrying about tax revenues coming in every January before it can start to undertake its work. That a purported shortage of cash has not stopped the government spending during the banking crisis, or coronavirus. That all government debt is “settled” with more debt instruments, whether cash or gilts.
Perhaps you have done this with students, but it would be interesting to canvass views from people who are not au fait with MMT to see where the sticking points are, and what argument work to make them check their assumptions and shift their view.
I am listening and noting.
The next layer will be out tomorrow.
“government spends the currency that it wants to be used to make settlement of the taxes owing to it ”
If my understanding of MMT is correct, I think the description is a little dry, and people won’t realise the corollary:
it means that taxes do not pay for government spending, and the government never needs “find” the money.
Likewise the Government Debt: consequently it is not a debt, and never needs repaying, and never has been. It is the nation’s wealth, our savings.
Richard your output is prodigious, but for me you second sentence here (the one beginning MMT suggest) is a really hard read. I hesitate to attempt a rewrite, but would it not be possible to break it down into 3 or 4 (maybe more) sentences?
I will look. The trouble is it would then be a lot longer.
For mere mortals like me the definition/description is overly complicated and needs simplification. This is of course subject to the audience you are targetting. Just saying.
Noted
So… we pay tax in order for the government to destroy the money they have spent in order to avoid inflation.
What about the money they ‘can’t’ destroy because it is stashed away in offshore accounts?
What about the money ‘lost’ to fraud such as in the billions thrown away on dodgy PPE etc.?
Can that money ever truly be ‘written off’ or is it the case that the rest of us carry the burden of that through direct and indirect taxation?
How does the government account for the vast sums lost to fraud? Do they just raise taxes in some devious way to make everyone else pay for it?
Money in offshore accounts is simply recorded there but is used by the bank assisting the process in the U.K.
It is not ‘lost’. It is saved. That does take it out of circulation, maybe, as far as the owner is concerned.
It may be untaxed, but that is the only oddity about it
And PPE money was not lost as such, it was just bs ku spent. But that has no impact on MMT
Your relevant comment is that tax fraud does increase tax to ensure that planned levels of tax are raised from someone else
An illustrative example/model with numbers would be helpful in order to understand the MMT concept in the current economic circumstances – setting out assumptions. eg increase in public spending required to meet social needs, any inflation impact and compensating tax change required , suggested reduction in interest rates etc?
In time I will do…I am human and really need yo address other things as well this eeek
I like this greatly. Thank you. My understanding of government economics has considerably deepened since I have been reading your output. I try to explain what MMT is to others & try to nudge them away from the neo-Thatcherite (nT) economics they have been brought up to believe without question. In the end I say to them – if such nT economic theory was right – we would have the case of our Govt saying they couldn’t afford to pay for defences in a time of war because they didn’t have enough taxes to do so… People then begin to grasp that nT economics has only ever been used to suppress not liberate people.
Keynes’s “How to Pay for the War” might be interesting if you haven’t read it already.
It is
Do you agree that MMT is not really a theory at all, is more a claim or argument about how the economy works? Perhaps the word theory is misleading, although it will not change anytime soon.
I have mentioned that in today’s paper
What do you understand by the word “theory” Brendan? And how do you differentiate that from “a claim or argument” or indeed an explanation?
Perhaps you are trying to distinguish between an untested hypothesis (“just a theory”), a well-substantiated explanation of some aspect of the natural world, based on a body of facts that have been repeatedly confirmed through observation and experiment (like a scientific theory), a framework that represents a model of reality (like a scientific model), and a proposition that is regarded as self-evidently true without proof (an axiom)?
To my mind, MMT is much more of a scientific theory or a scientific model than most classical nor neoliberal economics, which proceed on the basis of axioms and assertions but rarely trouble themselves with observing or measuring the real world, or making testable or falsifiable predictions. You can start with theoretical lines of supply and demand, markets that clear, and the idea of equilibrium in a situation of perfect information and no externalities.
Thanks Andrew
Richard
Do you not think that MMT totally ignores the psychology of money (and currency)? Money is faith and money is debt. Money both exits and doesn’t exist…it is figures or bits of paper and yet these manifestations only represent something else…value. This is made more difficult because of the different values people ascribe to same things but also more important because money is the great equalizer allowing a sausage (or about 100000) to be equated to a car (or a big mac if you read the economist). Tax and spend are important because those using the currency (as opposed to money) need to know that every pound is equal – remove that association at your peril. And you might ask why no monetary authority in the World has ever disassociated the two. The Church was rightly suspicious of ‘money’…it bids against God for our faith.
I am not sure what point you are making
Sorry
Richard,
Apologies if this is a dumb question. But since MMT is ‘global’ it should also model what happens where a large amount of a nation’s economy is performed in another currency (say Oil linked Dollars and Saudi Arabia). Does this translate into any action of the SA government is ‘less direct’ because they don’t control all of the money that is in their economy?
Also, assume that SA trades oil for USD …. if SA had no reason to purchase US products, what good would having USD be to the folk of SA? Is holding ‘foreign’ currencies in reserve useful for anything other than to buy things from that foreign state? Is a foreign state holding a currency the similar to a private saver keeping hold of money created by the government (it’s leaked out of the money cycle?)
MMT could be global.
At the same time it is always local to the currency being considered and the jurisdiction in question.
MMT suggests that a country with dual currencies functioning (and there are many, the US dollar usually being the alternative) is not in full control, of its macroeconomy, which is why so many end up in macro crisis and with debt default because they usually owe dollars but that is not within their control
To give a brief reply to Andrew, there are aspects of MMT which are factual, eg some governments can create money. Beyond that, as I understand it, MMT says a strong economy in a wealthy country can provide full employment and a good standard of living for all (at the very least I believe our government could do far more towards these ends as the ‘all in’ initiative for homeless people during the pandemic demonstrated). I don’t think that MMT is a theory but perhaps it doesn’t matter. I think it is a very good point that on ‘the other side we also have axioms, assertions and downright dogma, eg the claim that cutting taxes will lower the tax take, the private sector is always superior etc.
Have you read what I gave written this week?
Not yet.