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Modern Monetary Theory
Introduction
In the space of little more than a decade, Modern Monetary Theory has spread from a relatively small group of academics to become a mass movement for economic change.
In general terms, MMT is a macroeconomic paradigm based on an
understanding of monetary and fiscal dynamics that stands in stark
contrast to neoclassical, neo-Keynesian, and other mainstream
approaches. It is most well known for the claim that since monetarily
sovereign governments issue their own currency and determine the unit of
account, there are no purely financial constraints on public spending.
However, at its core is the recognition that money is a creature of
public law and state authority, not private exchange, and thus monetary
systems can and should be designed in ways that best further public
purpose.
Most modern economies use a ‘fiat’ currency, which gains acceptance
because it can be used to meet legal obligations imposed by the state,
and needn’t be convertible to a physical commodity (such as gold). Such
countries face no technical limit to the amount of money that can be
created. Therefore, there are no monetary constraints on a nation’s
prosperity – there are only the physical limits of the economy’s
productive capacity, and administrative, social, or political
constraints on utilising that capacity.
While MMT has roots in historical and theoretical discussions over
the nature of money, and its contemporary scholarship features
relatively technical analysis of the monetary operations of governments
and central banks, it has also acquired a broad appeal among progressive
campaigners. No one group claims sole ownership over the theory, but
prominent groups include the Modern Money Network and Sunrise Movement in the United States, Red MMT in Spain, Rete MMT in Italy, and the Gower Institute for Modern Money Studies (GIMMS) in Britain.
In the United States in particular, politicians and campaigners have
drawn on MMT principles to promote dramatically increased public
spending on social and environmental priorities, such as a ‘Green New
Deal’. Their arguments have begun to affect the national conversation
over economic policy.
MMT in 10
L. Randall Wray, an early member of the group of academics who refined and popularised MMT, explains
the paradigm in 10 points, intended to capture the logic of the MMT
position in a comprehensive way. The details of some of these points are
unpacked further down this page. Paraphrased, they include:
- Money is an IOU, because the issuer promises to
accept it back in payment of debts they are owed. That IOU is
denominated in a ‘socially sanctioned money of account’, usually
established by a centralised authority: the state. - Taxes (or other obligations) drive the currency. Sovereign states can impose obligations that give the currency value, since it can be used as payment.
- Anyone can issue money; the problem is to get it
accepted. People who try to issue an IOU in the unit of account without
support from the sovereign will struggle to make their promise credible. - ‘Redemption’ of money refers either to accepting it
as payment of taxes, or converting to gold, foreign currency, etc. on
request. However, the latter is no longer promised by the central bank
in countries with non-convertible, floating exchange rate currency
regimes. - There is no chance of an involuntary default on sovereign debt,
‘so long as the state only promises to accept its currency in payment’ –
in other words, so long as the debt is denominated in a floating,
non-convertible currency issued by the sovereign itself. - Functional Finance: the public finances should be
managed in a ‘functional’ manner, i.e. with an eye to the actual effects
of decisions in particular contexts, in order to achieve full
employment with price stability. This doctrine stands in contrast to
‘sound finance’, which evaluates budget decisions against predetermined
beliefs about the desirability of deficits and/or surpluses. - The Job Guarantee, a policy whereby the public
sector will employ anyone willing and able to work at a fixed wage, is a
critical component of MMT as a macroeconomic framework. It is thought
to anchor the currency and provide greater price and financial stability
than the alternative (i.e., than maintaining a pool of reserve
(unemployed) labour). - Hyman Minsky’s lessons on financial instability:
that periods of stability and growth see continual changes and increased
risk-taking in financial markets, which lead to a build-up of
instability such that ‘a slight reversal of prosperity can trigger a crisis.’ - The government’s debt is a non-government asset,
following from a view of sectoral balances across the macroeconomy. The
non-government sector (including households, firms, and the rest of the
world) must, as a simple fact of accounting, hold assets that correspond
to the liabilities of the government sector. - The central bank is neither independent nor potent – conventional
monetary policy, which operates primarily by manipulating the overnight
interest rate on lending between banks, is weak and its impact is at
best uncertain. In addition, monetary policy implementation always and
everywhere requires the coordination and support of the treasury. This
final point often leads to a preference for managing macroeconomic
conditions through coordination between fiscal and monetary authorities,
typically in the form of ‘permanent zero interest rate policy (ZIRP).
Wray’s 10 points reveal that MMT, like other schools of economics, is
a theoretical paradigm where certain dynamics in the economy follow
logically from fundamental premises, and from which policy insights can
easily be drawn.
Thought Genesis and History
Chartalism
MMT was initially known in academic literature as ‘Neo-Chartalism’.
Chartalism is a theory that stresses the importance of social context
for the existence of money. It is typically contrasted with the
‘orthodox’ (‘M-form’, ‘Metalist’, or ‘commodity money’) view, which
holds that money was invented to facilitate exchange, and that its value
was initially determined by the value of a physical commodity (e.g.
gold or silver) from which it was made. By contrast, Chartalism holds
that ‘the value of money is based on the power of the issuing authority,
and not by any embodied or backing precious metal’ (Wray, 2000).
Several important intellectual precursors to MMT held this view.
George Knapp argued in 1924 that ‘the attempt to deduce [money] without
the idea of a State [is] absurd’. This was an explicit contradiction of
commodity money – Knapp claimed that ‘the soul of the currency is not in
the material of the pieces, but in the legal ordinances that regulate
their use.’ Several years later, Abba Lerner also contributed to this
standpoint with an article entitled ‘Money as a Creature of the State’.
Neo-chartalism reorients the emphasis of monetary theory on the
currency systems prevalent in the world today, which, almost without
exception, are fiat currencies issued by sovereign governments. The
phrase ‘taxes drive money’ captures this recognition that the state
creates the value for a common currency by leveraging its centralised
authority. It does so by imposing non-reciprocal obligations (e.g. taxes
and fines) that can only be paid by tendering the currency.
Functional Finance
Building on the lessons of neo-chartalism, MMT next draws important
conclusions about the nature of public finance and government spending.
MMT scholarship has since applied the chartalist understanding of
money and taxation through analysis of the economy’s sectoral balances,
an approach pioneered by Wynne Godley. As Stephanie Kelton argues,
‘proceeds form taxation and bond sales are not even capable of financing
government spending since their collection implies their destruction.’
When the fiscal authority (Treasury) receives tax payments, the banking
system loses the same quantity of money in reserves. Similarly, the
purpose of bond sales is argued to be the same: draining reserves, and
thereby relieving pressure on the policy interest rate, due to the
incentives faced by banks holding excess reserves. The central bank
provides the reserves necessary to ensure bond sales clear.
This accounting logic gives a concrete, practical face to the
occasionally abstract theory of money that MMT is ultimately based on.
It also has radical consequences for how to understand the options for
fiscal policy faced by a monetarily sovereign government.
In 1943, Lerner wrote another article, ‘Functional Finance and the Federal Debt’. There, he staked out the position that:
‘government fiscal policy, its spending and taxing, its borrowing
and payment of loans, its issue of new money and its withdrawal of
money, shall all be undertaken with an eye only to the results of these
actions on the economy and not to any established traditional doctrine
about what is sound or unsound.’
Put differently, this means that there should be no concern over the
size of the government deficit on the grounds of ‘debt sustainability’
(or other axioms about the desirability of running a budget in balance
or in surplus). Insolvency of a monetarily sovereign government is
impossible.
Nevertheless, government spending adds to a real economy where
productive resources are used and prices are set; public spending must
take these ‘productivity enhancing’ factors into account. This is the
‘functional’ in Functional Finance – fiscal policy should be operated
with a view only to the function it serves in achieving real economic
effects. MMT scholar Bill Mitchell expresses the principle as:
‘the desirable deficit outcome at any point in time to be a
function of the state of non-government spending and the utilisation of
the productive capacity of the economy.’
Financial Instability
Alongside Knapp and Lerner, MMT is indebted to Minsky, who proposed
that ‘money manager capitalism’ – the form of economic order that became
ascendant in the post-war world – is inherently unstable.
In short, the implication of Minsky’s view was that a period of
stable and growing prosperity leads caution among private firms to
lapse. Firms, households and banks undertake ‘innovations’, engage in
speculative activity, and start to take on more risk, increasing
fragility in the economy. As the cycle continues, short-term debt is
increasingly used to cover interest charges on earlier investment. This
behaviour makes a crisis almost inevitable over a long enough stretch of
time (Minsky, 1982).
The privileged position Minsky occupies in the lineage of MMT has
affected contemporary thinkers. Many hold that the public financial
architecture must recognize that there there are multiple sources of new
purchasing power and investment beyond government spending. The
resultant purchasing power has consequences for economic activity, the
distribution of wealth and income, and financial stability, and so must
be addressed by any comprehensive paradigm. Public authorities must be
on guard against the effects of private money markets, even while the
government operates Functional Finance (for an example, see Warren
Mosler’s ‘Proposals for the Treasury, the Federal Reserve, the FDIC, and
the Banking System’).
Policy recommendations
It is important to recall that MMT is not prescriptive of specific
spending priorities. It simply undermines any objection to increased
public spending that is based on an idea of monetary scarcity, or that
the nation ‘can’t afford it’. Instead, as according to Functional
Finance, spending proposals should be assessed on the basis of their
effects on society and the economy.
Nevertheless, the intellectual framework for understanding the modern
economy that MMT provides offers several priorities and directions for
building government institutions. Éric Tymoigne and L. Randall Wray have
written that:
‘Financial stability, price stability and full employment… are
important goals that have to be met independently from one another by
putting in place structural policies that work independently of the
current political climate, and that manage as directly as possible the
goal that needs to be achieved.
MMT rejects the traditional trade-off between inflation and
unemployment, and does not rely on economic growth and fine-tuning to
reach full employment.’
An important plank in the MMT framework that helps to achieve these
goals is the Job Guarantee. The JG is a ‘buffer-stock’ scheme for the
job market where the state functions as ‘employer of last resort’.
Anybody who wants a job on the public scheme can have one at a fixed
wage; the scheme, therefore, absorbs workers displaced from private
sector employment. Mitchell (2000) claims that the JG wage ‘prevents
serious deflation from occurring and defines the private sector wage
structure’ (in the sense of providing a viable outside option for those
on low wages).
MMT reverses the typical role played by a nation’s economic
institutions, in that typical MMT policy platforms see fiscal policy,
and not the manipulation of interest rates by the central banks, as the
proper tool for controlling inflation. For MMT advocates, this is a
simple consequence of the fact that taxes destroy money, and also
follows from Wray’s 10th point: that a policy interest rate is a weak
tool for manipulating spending in the real economy.
For the part of the JG, Mitchell proposes a ‘Buffer Employment Ratio’
or incomes policy to keep the lid on inflation resulting from the
increased government spending such a scheme would require. (Importantly,
MMT advocates acknowledge that there are other sources of inflation
beyond excessive demand, and other tools that can address inflation in
general, ranging from better financial regulation (Minsky) to reducing
accounting control fraud (Bill Black) to improving market governance and
competition law (Fred Lee)).
Critiques & Responses
Despite its growing popularity, MMT has not enjoyed an easy reception
from the mainstream of economic thought and commentary. Eric Témoigne
and Wray classify critiques of the paradigm into five categories: ‘views
about origins of money and the role of taxes in the acceptance of
government currency, views about fiscal policy, views about monetary
policy, the relevance of MMT conclusions for developing economies, and
the validity of the policy recommendations of MMT’ (2013).
Some have questioned whether MMT really offers any novel lessons for
macroeconomic policy that aren’t already implicit as components of a
more conventional view, mainstream view. For instance, Simon Wren-Lewis
has argued that:
1. ‘MMT seems obsessed with the accounting detail of government transactions;
2. This seemed to lead to ideas that I thought were standard bits of macroeconomics.’
Similarly, an article
published in mid-2018 at the Institute for New Economic Thinking (INET)
by Arjun Jayadev and J. W. Mason claimed that ‘the analysis underlying
[MMT’s policy proposals] is entirely orthodox.’ They elaborate:
‘The difference between MMT and orthodox policy can be thought of
as a different assignment of the two instruments of fiscal position and
interest rate to the two targets of price stability and debt stability.
As such, the debate between them hinges not on any fundamental
difference of analysis, but rather on different practical judgements—in
particular what kinds of errors are most likely from policymakers.’
Jayadev and Mason accordingly target the switch in policy emphasis
from interest rate-fixing at the central bank to fiscal policy as the
main tool of macroeconomic stabilisation, a point that Wren-Lewis also
sees as the main divide between MMT and more ‘mainstream’ economic
thinking.
However, the INET authors’ argument addresses ‘the logic of the
functional finance position rather than MMT as a body of thought’, and
they admit to ‘make only limited references to MMT literature’.
This has led MMT scholars to respond that the economic paradigm they
have developed goes far beyond the implication of functional finance,
and rests on fundamentally different premises about the economy from
mainstream views (such as Kelton’s argument about the impossibility of
bond finance or taxation to fund government spending). The INET critique
also gives no room to the ideas on investment and financial dynamics
adopted from Minsky, which lead to differences between MMT and the
mainstream in terms of understanding the business cycle.
Finally, MMT advocates take issue with the assumptions about human
behaviour and macroeconomic dynamics used to structure the very formal
model used by Jayadev and Mason in their analysis (see Mitchell
for more detail). For example, MMT denies that there is a ‘natural’
rate of interest at which the economy will reach full employment, if
only it is set by the central bank (which can be prevented by the zero
lower-bound). In that sense, MMT advocates do not see their theory as a
‘preference’ for fiscal policy over monetary policy as a tool of
macroeconomic stabilisation. Instead, from an MMT perspective one of
those tools (monetary policy) can never achieve what it claims it can
achieve, whereas the other can.
Economic theory as a ‘lens’
One category of objections to the MMT narrative concerns how it
relates to the institutions and practices established to manage
government spending and monetary policy in reality. Some critics have
claimed that MMT has few lessons for modern economies. They argue that
legal structures – such as central bank independence and laws
prohibiting monetary financing of deficit spending – mean that MMT is
only true in a stylised world, and therefore lacks relevance to the real
one.
This as Bill Mitchell writes,
‘MMT identifies two levels of reality. The first level defines the
intrinsic characteristics of the the monopoly fiat currency issuer which
clearly lead us to understand that such a government can never run out
of the currency it issues and has to first spend that currency into
existence before it can ever raise taxes or sell bonds to the users of
the currency – the non-government sector…
The second level of reality [is] the voluntary institutional
framework that governments have put in place to regulate their own
behaviour. These accounting frameworks and fiscal rules are designed to
give the (false) impression that the government is financially
constrained like a household – that is, in context, has to either raise
taxes to spend or issue debt to spend more than it raises in taxes.’
Elsewhere, he describes MMT as a lens ‘which allows us to see the true (intrinsic) workings of the fiat monetary system.’
The power of MMT, then, lies in its ability to reveal the gap between
what is necessarily true about monetary systems, and other, contingent
facts that are only true under present circumstances. It shows that gap
for what it is: a political construct that persists only because our
society so chooses. Structures like central bank independence must be
argued for on their merits, and cannot be referred to as ‘how the world
really works’. Ultimately, MMT has become a much broader project than a
single economic theory, and is consistent with insights from historical,
anthropological, legal, and sociological approaches to understanding
money, the economy, and society. Increasingly, the future of MMT is
interdisciplinary.
References
Bell, S. (1998). Can Taxes and Bonds Finance Government Spending?.
Levy Economics Institute of Bard College, Working Paper No. 244, July
Bell, S. (2001). The role of the state and the hierarchy of money. Cambridge Journal of Economics, 25, 149-163
Knapp, G.F. (1973). The State Theory of Money. Clifton, Augustus M. Kelley [1924].
Lerner, A.P. (1947). Money as a Creature of the State. American Economic Review, vol. 37, no. 2, May, pp. 312-317.
Lerner, Abba P. (1943). Functional Finance and the Federal Debt. Social Research, vol. 10, 1943, pp. 38-51
Jayadev, A., and Mason, J.W. (2018). Mainstream Macroeconomics and
Modern Monetary Theory: What Really Divides Them? Institute for New
Economic Thinking, September. Available at: https://www.ineteconomics.org/perspectives/blog/mainstream-macroeconomics-and-modern-monetary-theory-what-really-divides-them
Minsky, H. (1982). Can “It” Happen Again? A Reprise. Hyman P. Minsky Archive. Paper 155. Available at: https://digitalcommons.bard.edu/hm_archive/155/
Mitchell, W. (2016). Modern Monetary Theory – What is New About It? Available at: http://bilbo.economicoutlook.net/blog/?p=34200
Mitchell, W. (2000). The Job Guarantee and Inflation Control. Centre
of Full Employment and Equity, Working Paper No. 00/01, January
Mosler, W. (2009). Proposals for the Treasury, the Federal Reserve,
the FDIC, and the Banking System. Draft, September. Available at: http://moslereconomics.com/2009/09/16/proposals-for-the-banking-system-treasury-fed-and-fdic-draft/
Tymoigne, Éric and Wray, L.R. (2013). Modern Money Theory 101: A
Reply to Critics. Levy Economics Institute of Bard College, Working
Paper No. 778, November
Wray, L.R. (2000).‘The Neo-Chartalist Approach to Money’. July. Available at SSRN: https://ssrn.com/abstract=1010334
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