Modern Monetary Theory

MMT synthesizes ideas from the State Theory of Money of Georg Friedrich Knapp (also known as Chartalism) and Credit Theory of Money of Alfred Mitchell-Innes, the functional finance proposals of Abba Lerner, Hyman Minsky's views on the banking system[16] and Wynne Godley's Sectoral balances approach.[12]

Knapp, writing in 1905, argued that "money is a creature of law" rather than a commodity.[17] Knapp contrasted his state theory of money with the Gold Standard view of "metallism", where the value of a unit of currency depends on the quantity of precious metal it contains or for which it may be exchanged. He argued that the state can create pure paper money and make it exchangeable by recognizing it as legal tender, with the criterion for the money of a state being "that which is accepted at the public pay offices".[17]

The prevailing view of money was that it had evolved from systems of barter to become a medium of exchange because it represented a durable commodity which had some use value,[18] but proponents of MMT such as Randall Wray and Mathew Forstater argue that more general statements appearing to support a chartalist view of tax-driven paper money appear in the earlier writings of many classical economists,[19] including Adam Smith, Jean-Baptiste Say, J.S. Mill, Karl Marx, and William Stanley Jevons.[20]

Alfred Mitchell-Innes, writing in 1914, argued that money exists not as a medium of exchange but as a standard of deferred payment, with government money being debt the government may reclaim through taxation.[21] Innes argued:

Whenever a tax is imposed, each taxpayer becomes responsible for the redemption of a small part of the debt which the government has contracted by its issues of money, whether coins, certificates, notes, drafts on the treasury, or by whatever name this money is called. He has to acquire his portion of the debt from some holder of a coin or certificate or other form of government money, and present it to the Treasury in liquidation of his legal debt. He has to redeem or cancel that portion of the debt...The redemption of government debt by taxation is the basic law of coinage and of any issue of government ‘money’ in whatever form.

— Alfred Mitchell-Innes, The Credit Theory of Money, The Banking Law Journal

Knapp and "chartalism" are referenced by John Maynard Keynes in the opening pages of his 1930 Treatise on Money[22] and appear to have influenced Keynesian ideas on the role of the state in the economy.[19]

By 1947, when Abba Lerner wrote his article Money as a Creature of the State, economists had largely abandoned the idea that the value of money was closely linked to gold.[23] Lerner argued that responsibility for avoiding inflation and depressions lay with the state because of its ability to create or tax away money.[23]

Economists Warren Mosler, L. Randall Wray, Stephanie Kelton,[24] Bill Mitchell and Pavlina R. Tcherneva are largely responsible for reviving the idea of chartalism as an explanation of money creation; Wray refers to this revived formulation as Neo-Chartalism.[25]

Bill Mitchell, Professor of Economics and Director of the Centre of Full Employment and Equity or CofFEE, at the University of Newcastle, New South Wales, refers to an increasing related theoretical work as Modern Monetary Theory.

Pavlina R. Tcherneva has developed the first mathematical framework for MMT[26] and has largely focused on developing the idea of the Job Guarantee.

Scott Fullwiler has added detailed technical analysis of the banking and monetary systems.[27]

Rodger Malcolm Mitchell's book Free Money[28] (1996) describes in layman's terms the essence of chartalism.

Some contemporary proponents, such as Wray, place MMT within post-Keynesian economics, while MMT has been proposed as an alternative or complementary theory to monetary circuit theory, both being forms of endogenous money, i.e. money created within the economy, as by government deficit spending or bank lending, rather than from outside, as by gold. In the complementary view, MMT explains the "vertical" (government-to-private and vice versa) interactions, while circuit theory is a model of the "horizontal" (private-to-private) interactions.[29][30]

Hyman Minsky seemed to favor a chartalist approach to understanding money creation in his Stabilizing an Unstable Economy,[16] while Basil Moore, in his book Horizontalists and Verticalists,[31] lists the differences between bank money and state money.

James K. Galbraith supports MMT and wrote the foreword for Mosler's book Seven Deadly Innocent Frauds of Economic Policy in 2010.[32]

Steven Hail of the University of Adelaide is another well known MMT economist.[33][34]

In February 2019, the first academic textbook based on the theory was published.[5]

In sovereign financial systems, banks can create money but these "horizontal" transactions do not increase net financial assets as assets are offset by liabilities. According to MMT adherents, "The balance sheet of the government does not include any domestic monetary instrument on its asset side; it owns no money. All monetary instruments issued by the government are on its liability side and are created and destroyed with spending and taxing/bond offerings, respectively."[3] In MMT, "vertical money" enters circulation through government spending. Taxation and its legal tender enable power to discharge debt and establish the fiat money as currency, giving it value by creating demand for it in the form of a private tax obligation that must be met. In addition, fines, fees and licenses create demand for the currency. This can be a currency issued by the domestic government, or a foreign currency.[35][36] An ongoing tax obligation, in concert with private confidence and acceptance of the currency, maintains its value. Because the government can issue its own currency at will, MMT maintains that the level of taxation relative to government spending (the government's deficit spending or budget surplus) is in reality a policy tool that regulates inflation and unemployment, and not a means of funding the government's activities by itself. The approach of MMT typically reverses theories of governmental austerity. The policy implications of the two are likewise typically opposed.

Vertical transactions

Illustration of the saving identity with the three sectors, the computation of the surplus or deficit balances for each and the flows between them[37]

MMT labels any transactions between the government, or public sector, and the non-government, or private sector, as a "vertical transaction". The government sector is considered to include the treasury and the central bank. The non-government sector includes domestic and foreign private individuals and firms (including the private banking system) and foreign buyers and sellers of the currency.[38]

MMT is based on an account of the "operational realities" of interactions between the government and its central bank, and the commercial banking sector, with proponents like Scott Fullwiler arguing that understanding reserve accounting is critical to understanding monetary policy options.[39]

A sovereign government typically has an operating account with the country's central bank. From this account, the government can spend and also receive taxes and other inflows.[29] Each commercial bank also has an account with the central bank, by means of which it manages its reserves (that is, money for clearing and settling interbank transactions).[40]

When the government spends money, the treasury debits its operating account at the central bank, and deposits this money into private bank accounts (and hence into the commercial banking system). This money adds to the total deposits in the commercial bank sector. Taxation works exactly in reverse; private bank accounts are debited, and hence deposits in the commercial banking sector fall. In the United States, a portion of tax receipts are deposited in the treasury operating account, and a portion in commercial banks' designated Treasury Tax and Loan accounts.[10][41]

Government bonds and interest rate maintenance

The Federal Reserve raising the Federal Funds Rate above U.S. Treasury interest rates creates an inverted yield curve, which is a predictor of recessions.

Virtually all central banks set an interest rate target, and conduct open market operations to ensure base interest rates remain at that target level. According to MMT, the issuing of government bonds is best understood as an operation to offset government spending rather than a requirement to finance it.[39]

In most countries, commercial banks’ reserve accounts with the central bank must have a positive balance at the end of every day; in some countries, the amount is specifically set as a proportion of the liabilities a bank has (i.e. its customer deposits). This is known as a reserve requirement. At the end of every day, a commercial bank will have to examine the status of their reserve accounts. Those that are in deficit have the option of borrowing the required funds from the central bank, where they may be charged a lending rate (sometimes known as a discount rate) on the amount they borrow. On the other hand, the banks that have excess reserves can simply leave them with the central bank and earn a support rate from the central bank. Some countries, such as Japan, have a support rate of zero.[42]

Banks with more reserves than they need will be willing to lend to banks with a reserve shortage on the interbank lending market. The surplus banks will want to earn a higher rate than the support rate that the central bank pays on reserves; whereas the deficit banks will want to pay a lower interest rate than the discount rate the central bank charges for borrowing. Thus they will lend to each other until each bank has reached their reserve requirement. In a balanced system, where there are just enough total reserves for all the banks to meet requirements, the short-term interbank lending rate will be in between the support rate and the discount rate.[42]

Under an MMT framework where government spending injects new reserves into the commercial banking system, and taxes withdraw them from the banking system,[10] government activity would have an instant effect on interbank lending. If on a particular day, the government spends more than it taxes, reserves have been added to the banking system (see vertical transactions). This will typically lead to a system-wide surplus of reserves, with competition between banks seeking to lend their excess reserves forcing the short-term interest rate down to the support rate (or alternately, to zero if a support rate is not in place). At this point banks will simply keep their reserve surplus with their central bank and earn the support rate.[43]

The alternate case is where the government receives more taxes on a particular day than it spends. In this case, there may be a system-wide deficit of reserves. As a result, surplus funds will be in demand on the interbank market, and thus the short-term interest rate will rise towards the discount rate. Thus, if the central bank wants to maintain a target interest rate somewhere between the support rate and the discount rate, it must manage the liquidity in the system to ensure that the correct amount of reserves is on hand in the banking system.[10]

Central banks manage this by buying and selling government bonds on the open market. On a day where there are excess reserves in the banking system, the central bank sells bonds and therefore removes reserves from the banking system, as private individuals pay for the bonds. On a day where there are not enough reserves in the system, the central bank buys government bonds from the private sector, and therefore adds reserves to the banking system.

It is important to note that the central bank buys bonds by simply creating money — it is not financed in any way.[44] It is a net injection of reserves into the banking system. If a central bank is to maintain a target interest rate, then it must necessarily buy and sell government bonds on the open market in order to maintain the correct amount of reserves in the system.[45]

MMT economists describe any transactions within the private sector as "horizontal" transactions, including the expansion of the broad money supply through the extension of credit by banks.

MMT economists regard the concept of the money multiplier, where a bank is completely constrained in lending through the deposits it holds and its capital requirement, as misleading.[46][47] Rather than being a practical limitation on lending, the cost of borrowing funds from the interbank market (or the central bank) represents a profitability consideration when the private bank lends in excess of its reserve and/or capital requirements (see interaction between government and the banking sector).

According to MMT, bank credit should be regarded as a "leverage" of the monetary base and should not be regarded as increasing the net financial assets held by an economy: only the government or central bank is able to issue high-powered money with no corresponding liability.[48] Stephanie Kelton argues that bank money is generally accepted in settlement of debt and taxes because of state guarantees, but that state-issued high-powered money sits atop a "hierarchy of money".[49]

Economist Stephanie Kelton explained several policy claims made by MMT in March 2019:

• Under MMT, fiscal policy (i.e., government taxing and spending decisions) is the primary means of achieving full employment, establishing the budget deficit at the level necessary to reach that goal. In mainstream economics, monetary policy (i.e., central bank adjustment of interest rates and its balance sheet) is the primary mechanism, assuming there is some interest rate low enough to achieve full employment. Kelton claims that cutting interest rates is ineffective in a slump, because businesses expecting weak profits and few customers will not invest at even very low interest rates.
• Government interest expenses are proportional to interest rates, so raising rates is a form of stimulus (it increases the budget deficit and injects money into the private sector, other things equal), while cutting rates is a form of austerity.
• Achieving full employment can be administered via a federally funded job guarantee, which acts as an automatic stabilizer. When private sector jobs are plentiful, the government spending on guaranteed jobs is lower, and vice versa.
• Under MMT, expansionary fiscal policy (i.e., money creation to fund purchases) can increase bank reserves, which can lower interest rates. In mainstream economics, expansionary fiscal policy (i.e., debt issuance and spending) can result in higher interest rates, crowding out economic activity.[7][8]

Economist John T. Harvey explained several of the premises of MMT and their policy implications in March 2019:

• The private sector treats labor as a cost to be minimized, so it cannot be expected to achieve full employment without government creating jobs as well, such as through a job guarantee.
• The public sector's deficit is the private sector's surplus and vice-versa, by accounting identity, a reason why private sector debt increased during the Clinton-era budget surpluses.
• Idle resources (mainly labor) can be activated by money creation. Not acting to do so is immoral.
• Demand can be insensitive to interest rate changes, so a key mainstream assumption, that lower interest rates lead to higher demand, is questionable.
• When the economy is below full employment, there is a "free lunch" in creating money to fund government expenditure to achieve full employment. Unemployment is a burden; full employment is not.
• Creating money alone does not cause inflation; spending it when the economy is at or above full employment can.[55]

MMT claims that the word "borrowing" is a misnomer when it comes to a sovereign government's fiscal operations, because what the government is doing is accepting back its own IOUs, and nobody can borrow back their own debt instruments.[56] Sovereign government goes into debt by issuing its own liabilities that are financial wealth to the private sector. "Private debt is debt, but government debt is financial wealth to the private sector."[57]

In this theory, sovereign government is not financially constrained in its ability to spend; it is argued that the government can afford to buy anything that is for sale in currency that it issues (there may be political constraints, like a debt ceiling law). The only constraint is that excessive spending by any sector of the economy (whether households, firms, or public) could cause inflationary pressures.

MMT economists advocate a government-funded job guarantee scheme to eliminate involuntary unemployment. Proponents argue that this can be consistent with price stability as it targets unemployment directly rather than attempting to increase private sector job creation indirectly through a much larger economic stimulus, and maintains a "buffer stock" of labor that can readily switch to the private sector when jobs become available. A job guarantee program could also be considered an automatic stabilizer to the economy, expanding when private sector activity cools down and shrinking in size when private sector activity heats up.[58]

MMT can be compared and contrasted with mainstream Keynesian economics in a variety of ways:[5][7][8]

A 2019 survey of leading economists by the University of Chicago Booth's Initiative on Global Markets showed a unanimous rejection of assertions that the survey attributes to modern monetary theory: "Countries that borrow in their own currency should not worry about government deficits because they can always create money to finance their debt" and "Countries that borrow in their own currency can finance as much real government spending as they want by creating money".[63][64] Directly responding to the survey, MMT economist William K. Black said "MMT scholars do not make or support either claim."[65] Multiple MMT academics regard the attribution of these claims as a smear.[66]

The post-Keynesian economist Thomas Palley argues that MMT is largely a restatement of elementary Keynesian economics, but prone to "over-simplistic analysis" and understating the risks of its policy implications.[67] Palley denies the MMT claim that standard Keynesian analysis does not fully capture the accounting identities and financial restraints on a government that can issue its own money. He argues that these insights are well captured by standard Keynesian stock-flow consistent IS-LM models, and have been well understood by Keynesian economists for decades. He also criticizes MMT for "assum[ing] away the problem of fiscal–monetary conflict"[68] — that is, that the governmental body that creates the spending budget (e.g. Congress) may refuse to cooperate with the governmental body that controls the money supply (e.g. the Federal Reserve). In Palley's view the policies proposed by MMT proponents would cause serious financial instability in an open economy with flexible exchange rates, while using fixed exchange rates would restore hard financial constraints on the government and "undermines MMT’s main claim about sovereign money freeing governments from standard market disciplines and financial constraints". He also argues that MMT lacks a plausible theory of inflation, particularly in the context of full employment in the employer of last resort policy first proposed by Hyman Minsky and advocated by Bill Mitchell and other MMT theorists; of a lack of appreciation of the financial instability that could be caused by permanently zero interest rates; and of overstating the importance of government created money. Palley concludes that MMT provides no new insights about monetary theory, while making unsubstantiated claims about macroeconomic policy, and that MMT has only received attention recently due to it being a "policy polemic for depressed times."[68]

Marc Lavoie argues that whilst the neochartalist argument is "essentially correct", many of its counter-intuitive claims depend on a "confusing" and "fictitious" consolidation of government and central banking operations[14] — again what Palley calls "the problem of fiscal–monetary conflict."[68]

New Keynesian economist and Nobel laureate Paul Krugman argues that MMT goes too far in its support for government budget deficits and ignores the inflationary implications of maintaining budget deficits when the economy is growing.[69] Krugman described MMT devotees as engaging in "calvinball" — a game from the comic strip Calvin and Hobbes in which the players change the rules at whim.[24] Austrian School economist Robert P. Murphy states that MMT is "dead wrong" and that "the MMT worldview doesn't live up to its promises."[70] He observes that MMT's claim that cutting government deficits erodes private saving is true "only for the portion of private saving that is not invested" and argues that the national accounting identities used to explain this aspect of MMT could equally be used to support arguments that government deficits "crowd out" private sector investment.[70]

The chartalist view of money itself, and the MMT emphasis on the importance of taxes in driving money, is also a source of criticism.[14] Economist Eladio Febrero argues that modern money draws its value from its ability to cancel (private) bank debt, particularly as legal tender, rather than to pay government taxes.[71]

• Modern Money Theory 101: A Reply to Critics—Working Paper No. 778 (Éric Tymoigne and L. Randall Wray; Levy Economics Institute of Bard College, P.O. Box 5000, Annandale-on-Hudson, NY 12504–5000, www.levyinstitute.org)
• Bill Mitchell's blog (Chartalism is denoted as "Modern Monetary Theory", there)
• Warren Mosler's blog
• New Economic Perspectives website
• Macroeconomic Balance Sheet Visualizer, visualizing and understanding important concepts in macroeconomics
• Modern Monetary Theory: A Debate (Brett Fiebiger critiques and Scott Fullwiler, Stephanie Kelton, L. Randall Wray respond; Political Economy Research Institute, Amherst, MA)
• Credit Writedowns, news and opinion site, from the MMT perspective
• Knut Wicksell and origins of modern monetary theory-Lars Pålsson Syll
• Evolution of Selected Economic Schools, a simplified diagram
• Modern Money Network