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An introduction to heterodox views of money and MMT (Part 2)

Phil Armstrong

The critical element in the market for money was the introduction of the gold standard. This introduction forced governments to subjugate the use of their budget to the requirement to maintain the value of the currency in terms of gold.

‘Finance – this was one its channels of influence – acted as a powerful moderator in the councils and policies of a number of smaller sovereign states. Loans and the renewal of loans hinged upon credit, and credit upon good behaviour. Since under constitutional government (unconstitutional ones were severely frowned upon) behaviour was reflected in the budget and the external value of the currency cannot be detached from the appreciation of the budget, debtor governments were well advised to watch their exchanges carefully and to avoid policies which might reflect upon the soundness of the budgetary position. This useful maxim became a cogent rule of conduct once a country had adopted the gold standard, which limited permissible fluctuations to a minimum’ (Polanyi, 1944, p14).

Under the gold standard the operational reality was different to the reality facing a government issuing its own fiat currency under floating exchange rates. When the gold standard operates the government, effectively, becomes a currency-user, ‘When the government buys anything other than gold, they have to have, so to speak, money in the bank to pay for it. The government, like everyone else, is prohibited from simply printing money to pay for the things it buys. Everything else [other than gold] on which the government spends is covered by taxes or borrowing.

Therefore, expenditures by the government from its account at the Fed are continuously offset by receipts of taxes or borrowed funds’ (Mosler, 2012, p. 40, parentheses added).

The international mechanism which allowed the gold standard to function was constructed over an extended period around the revolutionary utopian idea of a self-regulating market. In principle, when nations joined an international economic community using a gold standard, trade imbalances would be removed by gold movements (provided the system was allowed to work unhindered). A nation in deficit would pay in gold requiring, in principle, a reduction in its money supply the consequent deflation and contraction would restore competitiveness, raise exports and move its external account towards equilibrium. In contrast, the surplus country would receive the gold allowing monetary expansion. The consequent inflation and expansion would reduce competitiveness and, in turn the trade surplus would fall.

In practice such a process would be slow and painful and central banking could provide a defence; it could mitigate against the effects by stemming the gold flow by raising the bank rate. This would make holding a nation’s currency or its government’s bonds more attractive than previously in comparison to conversion into gold. The ‘go-to’ policy of nations facing a gold drain was to raise the bank rate. A higher interest rate should spread the adjustment burden by reducing the demand for bank credit, slowing growth of income and thus reducing the inflow of imports. This would be a far less painful form of adjustment than the deflation following from an outflow of gold. Such a policy, though, would represent a corruption of the self- regulating market for money as interest rates, in principle, should be left to the market and be arrived at the balancing point between the supply and demand for loanable funds in domestic currency.

Central banking can be viewed as an intrinsic part of a necessary counter- movement in Polanyian sense. It was an essential introduction under a gold standard. Without it, deflationary adjustment would be too painful.

Central banks however, would need to adjust their interest rates to the situation vis-a-vis protection of gold reserves, to this extent interest rates were ‘market determined’. The central bank could not set interest rates at a level suitable to optimise domestic performance, rather its priority was maintain the nation’s integrity as a member of the gold standard club.

‘Under nineteenth-century conditions foreign trade and the gold standard had undisputed priority over the needs of domestic business. The working of the gold standard required the lowering of domestic prices whenever the means of exchange was threatened by deprec- iation. Since deflation happens through credit restrictions, it follows the working of commodity money interfered with the working of the credit system. This was a standing danger to business. Yet to discard token money altogether and restrict currency to commodity money was out of the question, since such a remedy would have been worse than the disease.

‘Central banking mitigated this defect of credit money greatly by centralizing the supply of credit in a country, it was possible to avoid the wholesale dislocation of business and employment involved in deflation in such a way as to absorb the shock and spread its burden over the whole country’ (Polanyi, 1944, p 203).

So we can see that, in the days of the gold standard (and fixed exchange rate regimes), the government’s budgetary policy was constrained by external forces — effectively it had to act like a currency-user — and it’s central bank’s interest policy were not free to be used to pursue public purpose. The use of interest rates became part of the socio-political layer and their use had to be tailored to the needs of the self- regulating market.

Operational reality and the socio-political layer

I consider that it is analytically useful to explicitly separate the core or operat- ional reality from the socio-political layer. Such a separation allows us to distinguish those features which are intrinsic to the operation of the monetary system and those which are merely parts of a surrounding socio-political layer. We may consider the latter as externally or self-imposed constraints.

Should a nation decide to join the gold standard or a fixed exchange rate system, external constraints, especially with regards to fiscal and monetary policy decisions, follow and become embedded in the political layer. These constraints are essential requirements that allow the system to function without unbearable strain being placed on the economy. However, once no such external constraints exist, i.e. when a country issues its own fiat currency under floating exchange rates, much of what was once an essential element of the socio-political layer — required to support the operation of bygone monetary systems — now becomes a matter of choice. The retention of former modes of behaviour which were once necessary now becomes the voluntary acceptance of unnecessary constraints.

A different core monetary reality exists when countries issue their own fiat, non-convertible currency. In this situation governments are never revenue constrained. Government spending or lending always precedes taxation or bond sales. The central bank cannot carry out a ‘reserve drain’ before a ‘reserve add’. This argument seems irrefutable on logical grounds. In this real world, the need for ‘sound finance’ and ‘market-led’ interest rates disappears. They are anachronisms that are irrelevant. In the new core reality government spending needs to be adjusted so as to satisfy non- government sector tax liability plus net saving demands at the full employment level of income (deficit levels and debt ratios per se become unimportant in themselves) and the state can use its position as monopoly issuer of the currency to control the whole spectrum of interest rates. Requirements such as debt ceilings, prohibitions of direct debt sales to the central bank and the illegality of treasury overdrafts at the central bank are seen merely as voluntary constraints – they are not part of the true operational reality and if a political decision was made to remove them, the core monetary reality would still function in the same way.

We might reasonably ask why political constraints are retained once their appropriateness and usefulness have gone. It may be that most, if not all, leading politicians and their economic advisers do not understand monetary operations. If this is true it would be a worry! They may be stuck in fixed exchange rate logic when the ‘old rules’ applied. Alternatively, they may under- stand the system but choose to operate as if they were still constrained by membership of a fixed exchange rate system in order to apply strict budgetary practice to encourage efficiency. They may be so deeply attached to the idea of the primacy and hegemony of markets that they may be unaware that the power held by private markets has been ceded to them by states as a matter of deliberate policy. They may believe that the historic growth of market power to be a ‘natural’ and positive development; this means they are ‘naturally’ constrained in their actions. For example, a government may be concerned about the effect of a change in macroeconomic policy on interest rates, even though it possesses the intrinsic power to control the whole spectrum of rates. It needs to be noted, however, that the situation regarding the exchange rate is more complex (see Knapp, 1924, p. 216-230), as a nation state cannot know for sure the effect of a given economic strategy on the exchange rate. However, it is far from certain that adopting a full employment strategy would generate a catastrophic fall in the exchange rate, as pessimistic neo-liberals suggest, if the worst came to the worst, exchange controls could be used to control the rate; a small price to pay for full employment.

An understanding of MMT allows a clear distinction to made between different core monetary realities and their impact on the relationship between the operation of the monetary system and the socio-political layer in countries with their own currencies (such as the USA, UK and Japan) and those without (e. g. euro-using nations). It contends that, in the case of the latter, taxes and bond sales do fund public spending in an operational sense and are no longer considered to be voluntary constraints.

I accept that such an analytical division between a core monetary system and a socio-political layer may be unacceptable to many; other groups consider the ‘traditional’ view of taxation and bond sales as part of the fabric of a ‘socio-economic reality’ and as indispensable to the way capitalism operates in the real world. They consider them to be part of an unwritten social compact in which taxation must be seen as ‘financing’ public spending (the tax- paying public accepts its tax obligation because this money is ‘needed’ to pay for public services) and bond sales providing interest rates are the reward to the rentier class. In this view, they are not ‘voluntary’ additions to the system but an intrinsic part of its social reality (see Ingham, 2004, p. 56). In this view removal of the so-called ‘voluntary constraints’ may reduce the system’s ability to function efficiently or even destroy it completely.

So we might contend that acceptance or rejection of the validity of the analytical division is based on differing ontological views of the essential nature of a monetary economy. An under- standing of the applicability of the analytical division allows an economist to understand the origin of criticisms which may be levelled at advocates of MMT. We might consider the fundamental origin of these criticisms to be ontological. For critics of MMT, the so- called voluntary constraints are no such thing! They remain part of the operational reality and economic models need to take account of this. For critics the dichotomy is false.

Of course, criticisms of MMT come from many sources. For example, even those broadly sympathetic to the use of MMT are often ardent critics of MMT’s use of a consolidated treasury and central bank in their models – denying its validity (see Lavoie, 2011, for a ‘friendly critique’ and Palley, 2014, for a ‘less-than-friendly’ assault!) The application of the analytical division allows us to understand the basis for this critique. For advocates of MMT, it is perfectly reasonable to consolidate the treasury and the central bank when analysing operational reality. Indeed, should a nation wish to consolidate its central bank with its treasury in public ownership with both institutions explicitly working together to pursue public purpose it would have the ability to do so. More importantly, whether or not politics dictates that the two are considered as one or two entities, in reality treasuries and central banks must act in cooperation in the day-to- day operation of the monetary system if it is to function effectively.

For critics, the separation is part of core reality, capturing the true nature of the system, making consolidation invalid.

The implication is that, for critics of MMT, the separateness is essential for the efficient functioning of the core monetary system or, at least, is so widely considered to be so within the socio-economic environment that consolidation is a practical impossibility.

To recap, for supporters of MMT, the division between the treasury and the central bank is a matter of political choice. Consolidation, far from impairing the functioning of the system would support its function by removing unnecessary impediments to its effectiveness. Going further, it seems to me that an openly accountable consolidated central bank and treasury, pursuing public purpose would deliver the best results for the population and a monetary model based on this is effectively provided by MMT.

It seems that, from this perspective, the debates between MMT economists and their critics (both ‘hostile’ and ‘friendly’) are essentially ontological in nature; based, as they are, upon different views of what really counts as ‘reality’ in a capitalist system.

In summary, I believe MMT provides the best monetary models out there and highlights the existence of the additional policy space acquired by sovereign states following the closure of the gold window by Nixon and the adoption by most nations of floating exchange rates. We just need to encourage the use of this space to enhance the living standards of ordinary people.

The adoption of the self-regulating market – in particular, with reference to the market for money, the introduction of the gold standard — was a peculiar event. Viewed in Polanyian terms it involved the ‘disembedding’ of markets and required the structure and operation of the socio-political layer to become subjugated to the needs of the system. For current advocates of the ‘efficient markets’ hypothesis, that time is viewed with great nostalgia — the gold bugs are still out there. However, most nations now have a new core monetary reality, allowing democratic governments to ‘re-embed’ markets.

However, this is not enough; the political layer must change and reflect this new underlying reality. Optimists — and there are many of us out there — still believe that, eventually, after the neo-liberal storm has passed, a recognition of this new scope for improving living standards will emerge.

This article is a summary of the views expressed by the author in a longer paper, ‘Heterodox Views of Money and Modern Monetary Theory’, referenced in part 1 (ERAR v7, n5).


Ingham, G. (2004a), The Nature of Money. Oxford: Polity/Blackwell

Ingham, G. (2004b), ‘The Emergence of Capitalist Credit Money’ in in Credit and State Theories of Money. Cheltenham: Edward Elgar.

Knapp, G. F. (1924), The State Theory of Money. New York: Augustus M. Kelley (1973).

Lavoie, M. (2011). “The Monetary and Fiscal Nexus of Neo-Chartalism: A friendly critical look”,

Mosler, W (2012) Soft Currency Economics II. US Virgin Islands: Valance Mosler, W (2014)‘Reader’s [Armstrong, Phil’s] note to Palley’, Available from Feb. 14.

Palley, T (2014) “Modern Monetary Theory (MMT): The Emperor still has no clothes”,

Polanyi, K. (1944/1957) The Great Transformation. Boston MA: The Beacon Press.

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