Modern monetary theory (MMT) offers an analysis of the flow of money within our economy, and in undertaking this task it proceeds from some basic assumptions, including the propositions that bank credit money and banking reserves are (a) destroyed when federal taxes are paid and when Federal Treasury securities are issued to the non-government sector, and (b) created when the Federal Government spends into the non-government sector. This article examines what the analysis implies within an Australian context, although the ideas and conclusions are more generally applicable. However we must firstly define what is meant by money.
- What is money?
Most economic textbooks tell us that money is any entity which (a) is accepted and used by the public as a means of payment for taxes and debts and for purchasing goods and services — in other words it behaves as a medium of exchange; (b) can be used as a store of value; and (c) possesses a unit of account (which in Australia is called the Aus Dollar). There is also an implication that the range of monetary transactions occurring and permitted within the real economy will embrace an adequately sized marketplace of players.
There exist three widely recognised forms of money:
(a) Currency, by which we mean coins and banknotes.
(b) Bank credit money, an intangible form of money created by commercial banks in the accounts of their retail depositors.
(c) Banking reserves (exchange settlement funds), created in the depository accounts of commercial banks with the Central Bank (CB).
Items (a) and (c) are collectively sometimes referred to as the monetary base. The “money supply” – meaning money accessible and used by the nonbank sector – can be defined in various ways, the simplest definition (called narrow money) being the conjunction of bank credit money and currency in the hands of the nonbank sector.
- The Federal Treasury is not a bank
A number of economic commentators have suggested that the Federal Treasury behaves like a bank. In my opinion such a viewpoint is wrong, for the following reasons:
(a) Treasury does not take deposits from the public, or from the commercial banks.
(b) Treasury does not directly create credit money in the accounts of nonbanks (i.e. by contrast with commercial banks). When Treasury spends, it instructs the Central Bank to transfer reserves to the payee’s bank, which authorises that bank to create new credit money in the payee’s account.
(c) Unlike commercial banks, Treasury’s primary role is not the creation of financial assets via retail lending or the acquisition of commercial profit.
(d) Treasury does not lend reserves to commercial banks (i.e. by contrast with the latter, which often lend reserves to each other).
- Are Federal Treasury’s CB credits a form of money?
Given that the Federal Treasury is not a bank, the credits in its account with the Central Bank cannot be banking reserves (unlike those of commercial banks). And clearly these credits do not consist of bank credit money, which can only exist within the depository accounts that commercial banks make available to citizens and businesses. Neither is it currency, because it has no tangible form. So the question arises, are these Treasury credits a form of money in any sense at all? Officially, they are not a form of money for the simple reason that they are excluded from the monetary base and also from every measure of the money supply.
The following propositions relate to this question.
- A monetarily sovereign entity, i.e. one which has the power to create and destroy money, has no use for that money — and in particular does not need to store it.
- If the Federal Government Treasury is not a bank, then its “deposits” in the Central Bank necessarily have a different status to the deposits of commercial banks in the central bank.
- One of the essential requirements of any entity entitled to be called money is that it is used by (traded, loaned/borrowed between) a sufficiently large number of marketplace players who have similar status and objectives in regard to those operations. Bank deposits in the Central Bank satisfy this criterion, since all of the players are in competition with each other with the common objective of maximising their financial profit. In contrast, the Federal Government maintains an account with its Central Bank for a quite different purpose, and its spending has a different objective.
- These days Federal Australian Treasury bond sales do match net spending (deficit spending), and so appear to top up the notional Treasury balance at Australia’s Central Bank – the Reserve Bank of Australia (RBA). However this is a relatively new development, having been introduced in Australia under the guise of ‘sound financial policy’ in 1982, and is not the practice in some comparable economies, such as Canada. Thus the Australian Treasury has not, since 1982, borrowed directly from the RBA – by selling bonds directly to the RBA or by using any other accounting mechanism (sometimes described as Overt Monetary Financing). Prior to 1982, it did sell bonds directly to the RBA, which meant – to take the logic to its obvious limit – that any number appearing within the government account at the RBA was rendered functionally meaningless. The post-1982 voluntary constraint on government-RBA relations does not in any sense undermine monetary sovereignty, but it does appear to do so – by obscuring the fact that the Australian Government cannot ever become insolvent in its own currency, and is not limited by its ability to attract ‘money’ into its account at the RBA.
- The situation in the United States is a little different, in that the constraint on direct borrowing by the Federal Treasury is not voluntary, but is enforced by legislation. However even in this case the constraint may be easily bypassed if there happens to be a need to do so. Within Australia and the U.S. there exist statutory regulations to the effect that, whenever a difference over policy exists between Treasury and CB which cannot be resolved by negotiation, the will of Federal Treasury will ultimately prevail. So even if there happened to be a legislative constraint on direct borrowing, the Treasury could – if it so wished – issue a quantity of new bonds to the private sector and arrange for the CB to buy the same quantity of bonds from the private sector. The net result is obviously the equivalent of direct borrowing.
- The economic mainstream hold that the Federal Government’s “deposits” in its Central Bank account are a form of state fiat money, moreover one which is interchangeable with reserves. However the above propositions imply that such “deposits” are not money in any real sense of the word, but are merely accumulated credits in an operating account. An operating account records a financial reality, but this does not imply that it is a form of money in a functional sense.
On this basis it may be held that the central government stands alone – that is, not in competition with any other entities possessing accounts with the central bank, and that the entries in the Government’s RBA account do not function as money.