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Alternative paths to MMT

L. Randall Wray

The following is a blog by Prof L. Randall Wray which appeared in New Economic Perspectives in January 2020, based on part of a talk he gave at ICAPE [1]. It focuses on the chartal roots of modern monetary theory as a description of the monetary system – rather than on functional finance, balance sheets or the sectoral balance equation.

This description is framed within the context of the U.S. monetary system, however the general principles discussed also apply to the Australian monetary system.

First I’ll clearly state what MMT (Modern Monetary Theory) is and then outline four paths that lead to MMT’s conclusions: history, logic, theory and practice.

What is MMT? It provides an analysis of fiscal and monetary policy that is applicable to national governments with sovereign currencies.

There are four requirements that identify a sovereign currency: the national government

  1. chooses a money of account;
  2. imposes obligations (taxes, fees, fines, tribute, tithes) in the money of account;
  3. issues a currency denominated in the money of account, and accepts that currency in payment; and
  4. if the National government issues other obligations, these are also pay- able in the national government’s own currency.

There is another consideration that follows from these: if a country pegs, adopts a gold standard, or dollarizes, it doesn’t have a sovereign currency in reality because it is committed to delivering that to which it pegs. That can reduce the policy space – unless it has accumulated enough of the foreign reserve.

So what difference does a sovereign currency make? We argue that the sovereign currency issuer:

  • does not face a “budget constraint” (as conventionally defined);
  • cannot “run out of money”;
  • can always meet its obligations by paying in its own currency;
  • can set the interest rate on any obligations it issues.

Now what do the critics of MMT accuse it of? Let’s look at the top claims.

  1. Because MMT says that a sovereign government cannot “run out of money”, they claim that MMT says that government should spend without limit. Which implies that the goal of MMT is to cause hyperinflation.
  2. Because MMT says that a sovereign can always meet obligations as they come due, critics claim that MMT says deficits don’t matter.
  3. Because MMT says that government spends by keystroking credits to bank reserves, critics claim that MMT advocates forcing the central bank to print up money to pay for all government spending.

What MMT actually says is that current procedures adopted by the treasury, the central bank, and private banks allow government to spend up to the budget approved by the national legislature and signed by the head of state. No change of procedures is required.

What MMT emphasizes is that sovereign governments face resource constraints, not financial constraints. MMT has always argued that excessive spending – whether by government or by the private sector – can generate inflation.

Finally, a favourite criticism adopted by MMT’s heterodox frenemies is that MMT does not apply to many countries, such as Greece, Somalia, The Central African Republic, Congo, Zimbabwe, Liberia, Malawi, Mozambique, Ecuador or Honduras.

And because it does not apply to them, MMT is an America First fascist policy.

But what do all those countries have in common? They do not issue a sovereign currency. It has always been made clear by MMT what is meant by sovereign currency. MMT rigorously applies to sovereign currencies. That may be the minority in terms of numbers, but the countries with sovereign currencies probably account for three-fourths of global development.

That doesn’t mean that MMT scholars have ignored countries without sovereign currencies – I recommend especially the work of Bill Mitchell and Fadhel Kaboub – but our main focus has been on sovereign currency.

However I’m not going to go into the case of developing nations now. I’m going to move on to four paths to MMT.

We usually begin our explication with logic, based on the assumption that economists are good at logic. One would think so – with all their models using mathematics and deductive thinking. However, having worked for about 35 years in economics, with 25 of those years engaged in thinking about MMT, I have concluded that economists as a whole are terrible at logic. So let’s begin with history.

1 History

But economists are not much better at history than they are at logic. So let’s try a recent, simple, and clear example – one provided by Farley Grubb, the expert on America’s colonial currency.

The American colonial governments were always short of British coins (but prohibited by the Crown from coining their own) so they each came up with their own money of account (e.g. the Virginia pound), imposed taxes in that money of account, issued paper notes in the money of account, spent those paper notes, collected the notes from the payment of tax obligations, and then burned their tax revenue.

I told you it would be simple and clear. A one-sentence history of sovereign currency in Colonial America. If you wish to have more details, read Grubb.

I like several things about this example. First, it is clear that the colonies spent the notes first, then collected them in taxes. They could not possibly have collected paper notes in taxes if they had not first spent them because there were no other paper monies around.

Second, the colonies did not spend the tax revenue they received in the form of paper notes. They burned the notes. All of them.

In the tax laws they were described as “Redemption Taxes” with the expressed purpose of “redeeming” the paper notes removing them from circulation to be burned. Finally, the spending was “self-financing”.

Our argument is that this is the way it has worked for the past 4000 years, at least, as Keynes put it. That is the Modern Money period to which MMT applies

2 Logic

Again, let’s keep this simple. Warren Mosler provides the following example. He wanted his kids to wash his car. To motivate them he offered to pay them using his own business cards. “But dad, why would we want your cards – they are worthless.”

Well, he answered, I’m imposing a tax of five business cards today if you want access to food, clothing and shelter. “But how can we get the cards?” I’ll pay five business cards for washing the car.

Note how all the logic we learned from the history of Colonial currency applies: Warren has to spend first before collecting the cards; no taxes can be paid until Warren spends; and redemption of the cards in taxes removes them from circulation.

The car gets washed and the kids get fed. Taxes drive money and money mobilizes resources such as labour for car washing. In a nutshell, that’s our monetary system.

In modern economies there’s a couple of degrees of separation between tax- payers and the treasury — I’ll return to that.

3 Theory

MMT adopts the Knapp-Innes-Keynes State Money Theory as outlined in the Treatise, the Marx-Keynes-Veblen MTP and its Theory of Effective Demand as developed in Keynes’ General Theory, Schumpeter’s Ephor theory of banking developed in the Franco-Italian Circuit approach, Kalecki’s theory of profits, and the sectoral balance approach of Godley.

Together these components provide a coherent, stock-flow consistent hetero- dox theory of the role of money in the economy. It stands in stark contrast to the Neoclassical loanable funds and ISLM approaches that are fundamentally, irredeemably incoherent.

As the endogenous money approach insists, “loans make deposits and deposits make reserves”. Banks can never “run out of money” since they create it when they make loans, and central banks can never “run out of reserves” since they lend them into existence.

So far, so good. I think every heterodox economist as well as most central bank- ers are now on board with this. Bank money and central bank money are not scarce resources – we can have as much as we want (and we generally have more than is good for us as Wall Street’s banksters run wild).

Paradoxically, most of the heterodox and orthodox economists believe that the sovereign government, itself, faces a critical money shortage. Bankers can- not run out. And the central bank of a sovereign government cannot run out. But government faces a strict budget constraint, and exceeding it leads to disaster: Attacks by Bond Vigilantes. Insolvency. Bankruptcy. Hyperinflation.

The largest and most powerful economic entity the world has ever seen – the US Federal Government – must now get its fiscal house in order.

It relies too much on lending by the Chinese! Any day now the supply of dollars to Uncle Sam will cut be cut off! A run from the Dollar will reduce its international purchasing power to peanuts! Our profligate government is leaving hundreds of trillions of dollars of debt to our grandkids!

If I say that the heterodox approach insists that injections are causally prior to leakages, you all recognize that from fundamental Keynesian theory.

And if I say that government spending is an injection and taxes are a leak- ages, then everyone understands.

But when I say that government spending is logically prior to taxes, heterodox economists suddenly get all dazed and confused.

If I say government has to spend first before taxes can get paid, I’m called crazy.

Government spending cannot be financed out of taxes – it must precede taxes. It is one of the injections that creates income that can be used to finance leakages such as saving and taxes.

So Government spending cannot be financed out of savings, either. Government spending must create the income that can be saved in the form of purchased government bonds.

This is all just basic macroeconomics. While an individual can pay taxes or buy bonds out of her savings, this is not possible at the aggregate level. Our heterodox frenemies all flunk first year macro theory.

The US government’s budget deficit is the normal injection that allows our domestic private sector to net save, and as well allows the rest of the world to net save US dollars. Neither domestic saving nor foreign saving can be a source of finance for US government spending.

The US government spends only dollars, in the form of reserves issued by the Fed and credited to private bank accounts at the Fed. Tax receipts are

almost solely received in the form of Fed reserves debited from private bank accounts held at the Fed.

To the extent that foreign central banks hold dollars, they came from the US and are held in the form of reserve deposits at the Fed, US Treasuries, or Fed notes.

The US government must issue dollars in the form of reserves before it is able to receive them—just as banks must supply deposits before they can receive them in payment.

4 Practice

I will be brief on institutional practice — this is something MMT has focused on since the very beginning. Before we documented how the government really spends, no academic economist had any idea. Now it drives our critics crazy and they complain that every time they criticize MMT we go so deeply into the accounting details that it blows their challenged minds.

In an earlier period, governments just notched tally sticks, minted coins, or printed paper money when they spent, then collected them in redemption taxes and burned or melted them.

Today all modern governments make use of their central banks to make and receive all payments. That’s one degree of separation. Central banks make and receive all payments through private banks. That’s the second degree of separation. Two degrees of separation is so complicated that critics throw up their hands in exasperation when we insist that nothing significant has changed.

Oh, it is all just too complicated!

Government spending is still financed by money creation, and taxes destroy money—in the form of central bank reserves. Instead of wooden sticks, we use electronic keystrokes. Government cannot run out.

Part of a US $100 star note (Gisela Giardino, Flickr cc). Note the Treasury Secretary’s signature.

The central bank will not say no. From its perspective, it never violates the US statutory prohibition against “lending” to the treasury. It simply ensures that the payments system functions smoothly.

Furthermore, government never needs to borrow its own currency. Bond sales by a sovereign government are not really a borrowing operation – but rather they provide a higher interest earning substitute for central bank reserves.

This was Warren Mosler’s key contribution, recognized before there was an MMT, and it made him rich because he concluded that credit ratings agencies had no idea what they were doing when they downgraded sovereign government debt.[su_spacer size=”10″]

Part of an Australian $5 banknote (AGeekMom, Australian Currency, Flickr cc) Note the signatures of the RBA Governor and the Treasury Secretary

The federal government can make all payments as they come due. Bond vigilantes cannot force default. While their portfolio preferences could affect interest rates and exchange rates, the central bank’s interest rate target is the most important determinant of interest rates on the entire structure of bond rates. The exchange rates are more complexly determined, but Keynes’s interest rate parity theorem provides a guide.

The Fed is a creature of Congress, and Congress can seize control of interest rates any time it wants. In any event, bond vigilantes cannot hold the nation hostage – the central bank can always overrule them. In truth, the only bond vigilante we face is the Fed. And in recent years it has demonstrated a firm commitment to keep rates low.

Finally, even if the Fed abandons low rates, the Treasury can “afford” to make all payments on debt as they come due, no matter how high the Fed pushes rates. Affordability is not the issue. The issue will be over the desirability of making big interest payments to bond holders. This is a particularly inefficient form of government spending. In the case of the US, half the bonds are held abroad and most of the rest are held by institutions. There isn’t much “bang for the buck” that comes from spending on interest.


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