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Introduction: The Basics of MMT

Modern Money Theory (MMT) is a relatively new approach to macroeconomics that focuses on building an understanding of the operation of sovereign currency systems and on developing a policy framework based on that understanding. The earliest expositions of MMT were Mosler (1995) and Wray (1998); a recent ‘primer’ on MMT is Wray (2012; new edition 2015). In this section we begin with a definition of sovereign currency and then summarise the basic conclusions of MMT.

Sovereign Currency

A sovereign currency system is one in which the government issues its own currency denominated in its money of account. Typically, it denominates taxes and other obligations in the same currency, and its courts enforce contracts in the official money of account. Private entities normally denominate most money contracts as well as prices in the sovereign’s money of account. Across the world and throughout recorded history, most nations have adopted sovereign currency systems. Examples of sovereign currency systems include the USA, the UK, Mexico, Russia and South Africa.

A sovereign currency system can be contrasted with one in which the government adopts a foreign currency or operates with a currency board arrangement. For example, a number of countries today have adopted the US dollar for domestic use, such as Panama, Ecuador and El Salvador, or issue their own currency convertible to the US dollar. Others have operated currency boards based on foreign currencies, such as Hong Kong and Argentina in the 1990s (both pegged to the dollar, although Argentina abandoned the dollar in 2002 in the depths of a crisis), and Singapore (which uses an undisclosed basket of currencies). With a traditional currency board, the country promises to convert its currency to the foreign currency on demand at a fixed rate. By far the boldest experiment of operating without a sovereign currency system is the entire European Monetary Union, in which each member nation dropped its currency and adopted a ‘foreign’ currency, the euro. The classical gold standard – in which the currency is convertible on demand to bullion at a fixed exchange rate – is another example of a non-sovereign currency system.

Countries that operate with sovereign currency systems can choose to manage their exchange rates. At one end of the spectrum, a country can adopt a floating exchange rate. At the other end, it promises to convert its own currency to a foreign currency (or to precious metal) at a fixed exchange rate. Most countries operate somewhere between the two extremes, with no promise to convert but managing the exchange rate within an informal range. Note that a country that operates with a firm peg (to gold or foreign currency) can be analysed as a non-sovereign currency system.

MMT argues that when a country issues its own currency and operates with a flexible exchange rate it obtains the greatest degree of domestic policy space. Because it does not promise to provide a foreign currency (or gold) in exchange for its currency, it has greater freedom to use monetary and fiscal policy to achieve domestic goals. If it pegs, it must consider the impacts of policy on demands to convert its currency and so must build into its policy some constraints to ensure that everybody believes convertibility on demand is possible. Generally, countries that tightly manage their exchange rates will formulate policy with a view to ensuring the accumulation of foreign currency or gold reserves, which can conflict with the pursuit of domestic policy goals such as full employment, growth and rising living standards.

Finally, a government with its own sovereign currency generally issues bonds denominated in that currency, servicing the debt with payments made in its own currency. However, it might choose to (or believe it must) issue debt in a foreign currency – in which case its policy space is constrained, as discussed above.

Taxes Drive Currency

A government that issues sovereign currency can choose the money of account, denominate taxes and other obligations such as fees and fines in that money of account and make and receive payments in its sovereign currency. By imposing taxes and other obligations on citizens payable in the sovereign’s currency, government ensures there will be a demand for its currency. (For references to the idea that ‘taxes drive money’ in the history of thought, see Forstater 2005a, pp. 216–17.)

If citizens need currency to pay taxes, they will provide labour and other resources to government to obtain the currency. MMT argues that a tax payable in the currency is sufficient to drive the currency, since the citizens will want at least enough of it to pay taxes. (See Bell 2000; Tcherneva 2006.) Indeed, they will probably want more to save for the proverbial ‘rainy day’. With a broad-based tax, the demand for currency will be generalised throughout the nation, leading to its use in third party transactions (within the nongovernment sectors).

Note that from inception government must provide the currency before taxes can be paid. Government can either spend or lend the currency into the economy. If government spends more than it taxes, it incurs a deficit with currency accumulating in the nongovernment sector. From inception, government cannot collect more currency in payment than it has issued. If over some period the government taxes more than it spends, the nongovernment sector dis-saves (runs down its currency balances accumulated during previous government deficits) or borrows currency from the government (goes into debt) to make the payments (with the government recording a budget surplus and accumulating credits against the nongovernment sector).

Sovereign Government Cannot Run Out of Its Own Currency and Cannot Be Revenue Constrained

The currency issuer cannot run out of currency that it spends or lends. Even if government does peg to gold or a foreign currency, it cannot run out of its own currency – but it can run out of whatever reserve it has promised for conversion. This is why countries that do not float their currencies can face diminished domestic policy space. Those that do float have more space, although they still might worry about the impacts of their spending (and lending) on exchange rates and on domestic inflation.

More generally, currency issuers can face resource constraints – as they hire labour and make purchases, they move resources to the government sector. At some point they begin to compete with private users of these resources, and can set off a bidding war that pushes up prices and wages. The danger of too much spending is inflation – not that government will run out of money to spend. In such a circumstance, government can either cut its spending or raise taxes (to push the nongovernment sector to reduce its spending) to prevent inflation.

Sovereign Government Does Not Face Solvency Risk in Its Own Currency and Cannot Be Forced into Involuntary Default

The currency issuer cannot be forced to default on its commitment to make a payment in its own currency. If government promises to pay wages, make a social security payment or pay interest in its own currency, it can always make that payment by issuing its currency. It might choose to default on its promise, but it cannot be forced to default against its will. However, a government that promises to convert its currency to foreign currency or gold, or that borrowed in foreign currency, might be forced to default if it cannot obtain sufficient reserves to meet the demand for conversion.

Sovereign Government Does Not Need to Borrow Its Own Currency in Order to Spend

If sovereign government can issue currency to finance its spending, why does it sell bonds? First, it is clear that government doesn’t have to sell bonds so long as its currency is accepted in payment. It is hard to conceive of a plausible situation in which a modern developed nation would offer its currency in payment but find no domestic takers (while perhaps slightly more plausible, it is also difficult to believe that even foreign sellers would turn down currency, since they could take it to foreign exchange markets). The question, again, is whether currency-financed purchases might cause inflation and/or currency depreciation. In other words, the currency will be accepted, so the only question is about the price or exchange rate.

Second – and this gets a bit more technical – if one looks at the operational impact of bond sales, they essentially substitute one kind of government liability for another. Government accepts its own IOUs (technically, reserves, which are a part of high powered money – reserves plus cash – also called monetary base) in payment by buyers of another of its IOUs (government bonds). The main difference between reserves and bonds is that the latter pay higher interest rates. When government sells bonds, the nongovernment sector trades very short-term and low-interest-earning reserves for higher-earning and generally longer-term bonds. Note also that government is the source of both reserves and cash (reserves come from the central bank; typically, coins come from the treasury and paper notes come from the central bank) – and government must spend or lend those before the nongovernment sector can offer them in purchase of bonds. Hence the logic is that bonds are sold after government has already spent.

MMT sees sovereign bond sales as part of monetary policy operations rather than as a funding operation for government. By contrast, most economists see bond sales by the central bank (open market sales) as monetary policy, but sales of new issues by the treasury as part of fiscal policy. MMT argues that these are operationally identical, at least from the perspective of the nongovernment sector. Whether bonds are sold by the central bank or by the treasury, they reduce reserves held in the banks, which relieves downward pressure on interest rates. Bond sales – whether by the central bank or treasury – are an important lever that facilitates central bank interest rate targeting. (In the case where banks find themselves short of reserves – which pushes rates up – the government reverses policy, buying or retiring bonds and replacing them with reserves.)

Central Banks Are Never Really Independent

Central banks coordinate operations with the government’s treasury. They act as the treasury’s bank, making and receiving payments for government. They ensure that the treasury’s cheques never bounce. Since they target interest rates, they cooperate with fiscal operations to ensure that when government spends or receives taxes, this does not affect bank reserve holdings in a way that would cause the interest rate to deviate from target. For this reason, they really cannot act independently from the treasury. Indeed, in times of unusual stress (such as major wars), the central bank is sometimes placed under the treasury’s oversight.

For Every Surplus There Must Be a Deficit

A fundamental principle of macroeconomics accounting is that aggregate spending must equal aggregate income; all spending flows must go to someone as income. If one spends more than her income, another must spend less; if one sector of the economy spends more than its income, another must spend less. MMT frequently divides the national economy into three sectors: domestic government (including national, state or province, and local), domestic private (including households, firms and not-for-profits) and foreign (foreign governments, firms, and households). While any sector can run a deficit (spend more than its income), that means that at least one of the other sectors must run a surplus (spend less than its income). Surplus sectors accumulate claims on deficit sectors; at the aggregate level, these claims (credits) accumulated by the surplus sectors equal the debts issued by the deficit sectors. If government runs a deficit, at least one of the other sectors (domestic private or foreign) must run a surplus; if government runs a surplus, at least one of the others must run a deficit.

Full Employment Is Affordable

The sovereign currency issuer can always afford to buy anything that a seller is willing to sell for that currency. This includes labour services. In other words, government can always afford to hire anyone who wants to work for wages paid in the government’s currency. If the government does pursue a policy to maintain full employment, the potential dangers are rising wages and inflation, depreciation of the currency and removing labour resources from desirable uses in the private sector.

Non-affordability, i.e. running out of money, is not an issue for sovereign government and so is not a proper justification for policy choice. For example, social security cannot go bankrupt and solving the social security problem involves solving any real resource problems, not resolving (nonexistent) financial problems.

In the next section we provide a brief summary of the intellectual origins of MMT; in the final section we conclude with the most important policy implications.

The Foundations of Modern Money Theory

Modern Money Theory rests ‘on the shoulders of giants’, reviving the State Theory of Money (or Chartalism) and integrating it with a variety of heterodox approaches to macroeconomics, including the credit, circuitiste and endogenous approaches to money, the functional finance approach to budgeting, the financial instability hypothesis, and the sectoral balances approach. (See Mosler 2010; Wray 1998; Wray 2012/second edition 2015 for the MMT, state and endogenous money theories, as well as Graziani (1990) and Parguez and Seccarrecia (2000) for the circuit approach.) It draws heavily on historical, anthropological, sociological and legal interpretations of the nature of money, while also providing close analysis of modern monetary operations. (See Ingham 2005.) It is critical of orthodox approaches to fiscal and monetary theory and policy.

G. F. Knapp developed the State Theory of Money (published in German in 1905 and translated to English in 1924), building on Simmel’s (1907) sociological approach to money (as well as the related German Historical approach). J. M. Keynes’s Treatise on Money (1930) adopted Knapp’s views on the role played by the state in choosing the money of account and in enforcing its use in payments:

The State, therefore, comes in first of all as the authority of law which enforces the payment of the thing which corresponds to the name or description in the contracts. But it comes in doubly when, in addition, it claims the right to determine and declare what thing corresponds to the name, and to vary its declaration from time to time – when, that is to say, it claims the right to re-edit the dictionary. This right is claimed by all modern states and has been so claimed for some four thousand years at least. (Keynes 1930, p. 4)

He goes on to argue that ‘Chartalism begins when the State designates the objective standard which shall correspond to the money-of-account’ (Keynes 1930, p. 11). ‘[M]oney is the measure of value, but to regard it as having value itself is a relic of the view that the value of money is regulated by the value of the substance of which it is made, and is like confusing a theatre ticket with the performance’ (Keynes 1983, p. 402). Money’s ‘substance’ (whether stamped on coin or paper, or keystroked onto a computer’s hard drive) is just a ‘ticket’, or record-keeping; but what is important is that value is measured in terms of the money unit (including credits and debits denominated in that unit).

Keynes also seems to have been influenced by A. M. Innes, who independently integrated state and credit approaches to money in two articles published in a banking law journal (1913, 1914, reproduced in Wray 2004). Keynes actually reviewed the first of these articles in his Economic Journal, arguing that while some of the details might be subject to critique, the general argument appears correct (Keynes 1914). Of particular note was Innes’s rejection of the typical approach to the origins of money – which supposes that money was created as a transactions cost-reducing innovation – and his speculation on money’s true history, which can be traced through the innovation of measuring debt in a universal money of account. This seems to have led to what Keynes called his ‘Babylonian Madness’ – a period during which he explored the history of the earliest known monetary units, showing that they were always based on a specific number of grains of wheat or barley (Keynes 1983, pp. 233–6; see Ingham 2004, for a discussion of this period and for the creation of an abstract measuring unit). What this meant – for Knapp, Innes and Keynes – is that the money of account likely originated for official record-keeping purposes of debts and payments rather than evolving ‘naturally’ out of exchange based on barter.

Innes called his approach the ‘Credit Theory of Money’ and opposed it to the ‘Metallic Theory’, ‘which has hitherto been held by nearly all historians and has formed the basis of the teaching of practically all economists on the subject of money’. More recently, Goodhart (1998) likewise distinguished between ‘M’ (metal, or Monetarist) form and ‘C’ (Cartalist or Chartalist) form, arguing that while the former can (still) count far more proponents, it is the latter that is supported by historical and anthropological evidence. The great numismatist Philip Grierson (1977) argued that the money of account probably developed out of the ancient tribal practice of wergild – imposing fines on transgressors, payable to victims, to prevent blood feuds – which emphasises the role played by authorities in choosing the nominal measuring unit and in enforcing obligations. Later, the system evolved to one in which obligations are to the authorities, denominated in the generalised money of account.

For application of this idea to the use of taxes to drive money in Africa, see Forstater (2005b, pp. 62–3):

Direct taxation was used to force Africans to work as wage laborers, to compel them to grow cash crops, to stimulate labor migration and control labor supply, and to monetize the African economies. Part of this latter was to further incorporate African economies into the larger emerging global capitalist system as purchasers of European goods. If Africans were working as wage laborers or growing cash crops instead of producing their own subsistence, they would be forced to purchase their means of subsistence, and that increasingly meant purchasing European goods, providing European capital with additional markets. It thus also promoted, in various ways, marketization and commoditization. We have also seen that taxation was related to a variety of ideological aspects related to the reproduction of colonial relations of production. Direct taxation was thus an important ‘secret of colonial capitalist primitive accumulation.’ It appears to have been one of the most powerful policies in terms of its wide variety of functions, its universality in the African colonial context, and its success in achieving its intended effects. Of course, taxation was not the sole determinant of primitive accumulation. But it has certainly been under-recognized in the literature on primitive accumulation. The history of direct taxation in colonial capitalism also has some wider theoretical implications. It shows, for example, ‘that “monetization” did not spring forth from barter; nor did it require “trust” – as most stories about the origins of money claim’ (Wray 1998, p. 61). In the colonial capitalist context, money was clearly a ‘creature of the state.’

J. Schumpeter (1934) distinguished between a ‘Money Theory of Credit’ and a ‘Credit Theory of Money’. The first sees private ‘credit money’ as only a temporary substitute for ‘real money’. Final settlement must take place in real money, which is the ultimate unit of account, store of value and means of payment. Exchanges might take place based on credit, but credit expansion is strictly constrained by the quantity of real money. Ultimately, only the quantity of real money matters so far as economic activity is concerned.

Most modern macroeconomic theory is based on the concept of a deposit multiplier that links the quantity of privately created money (mostly bank deposits) to the quantity of high-powered money (HPM, which includes central bank reserves plus currency). This is the modern equivalent to Schumpeter’s monetary theory of credit, and Friedman (or Brunner) is the best representative. In that view, the real money that is the basis of deposit expansion should be controlled, preferably by a rule that will make the modern fiat money operate more like the metallic money of the hypothesised past. (See Samuelson (1973) for the classic story of money’s origins, from barter through commodity money and finally to fiat money.)

The credit theory of money, by contrast, emphasises that credit normally expands to allow economic activity to grow. This new credit creates claims on HPM even as it leads to new production. However, because there is a clearing system that cancels claims and debits without use of HPM, credit is not merely a temporary substitute for HPM. Schumpeter does not deny the role played by HPM as an ultimate means of settlement; he simply denies that it is required for most final settlements. The modern exponents of the credit theory of money include the Franco-Italian circuit approach (Graziani 1990) as well as the post-Keynesian endogenous money theory (Moore 1988; Wray 1990). Circuitistes envision a production process that begins with a bank loan to a firm, which hires labour to produce commodities. Banks create deposits credited to the accounts of firms as they make the loans, which are then transferred to workers as wages are paid. When households purchase output using their wages, the deposits are returned to firms, which can repay loans – closing the circuit as the deposits are debited.

Extensions to the theory have been made to allow for generation of profits and for payment of interest. For the MMT perspective on the monetary circuit, see Mosler et al. (1999, p. 177):

This paper outlines an alternative way of viewing the monetary circuit that takes into consideration the central role of the State from the beginning of the analysis. Vertical and horizontal components of the monetary circuit were introduced and their relation analyzed. It was shown that this framework is applicable not only to currency, but to any commodity. This is because, while currency does not obtain its value by virtue of its status as a commodity, once endowed with value a tax driven currency can be analyzed like any other commodity.

The distinction between money and credit is not accepted by MMT, which is aligned with the credit theory. All monetary instruments are credit instruments, even HPM, because all of them represent promises of their issuer. Government promises to accept its currency in payments owed (taxes, fees and fines), and banks promise to accept their own monetary IOUs in payments owed to them. (They also promise to convert some of their liabilities to HPM on demand or after some waiting period – see below.) In fact, anybody can create a monetary instrument – i.e. create legal promises that are of a monetary nature – the problem is to get them accepted, as Minsky (1986) argued.

The endogenous money approach has focused on the implications of bank credit creation for supposed control by the central bank of the money supply. Since banks need reserves for clearing among one another and in some cases (such as in the USA) to meet legally required reserve ratios, the central bank normally accommodates the demand for reserves. The consequences of a central bank refusal to provide needed reserves are twofold: the central bank would lose control of the overnight interest rate and the smooth operation of the clearing system would be jeopardised. Hence, in practice, central banks always accommodate bank demand for reserves, albeit at the policy interest rate chosen by the central bank. In other words, central banks operate with interest rate targets, not reserve or money supply targets.

In recent years, this view has become accepted by most monetary policy-makers, even if the old ‘deposit multiplier’ is still presented in textbooks (Sheard 2013).

Post-Keynesians summarise the money creation process as ‘loans create deposits’ (banks create deposits in their loan-making activity) and ‘deposits create reserves’ (the central bank always accommodates the demand for expansion of the supply of reserves as needed when deposits grow). This effectively reverses the logic of the textbook money multiplier exposition, even as it deals a fatal blow to the Monetarist policy rule that would have the central bank grow the money supply at a constant rate. Instead, the money supply grows as banks accommodate the demand for loans, with monetary policy-making consisting of setting the overnight rate target (which might, or might not, indirectly affect money growth).

Lerner (1943, 1947) developed the functional finance approach to sovereign government budgeting in the early post-war period to counter the belief of ‘sound finance’ that government ought to try to balance its budget. He posed two principles: the government’s budget should balance only at full employment; if there is unemployment, government ought to spend more or reduce taxes; and (2) government ought to offer more bonds only if nongovernment sectors want to hold less money; if nongovernment sectors want to hold more money, government should reduce the supply of bonds. The first principle concerns the goal of fiscal policy – which is to set the budget so as to achieve full employment and without regard to whether that means a budget deficit (or balance, or surplus) will result. The second sets the monetary policy goal, which is to ensure that bank reserves are consistent with hitting the interest rate target. However, Lerner has integrated fiscal and monetary policy because the second principle would require that budget deficits are ‘money financed’ rather than ‘bond financed’ if the nongovernment sector’s portfolio preferences are biased toward holding ‘money’.

This is similar, although not identical, to a proposal by Friedman (1948), which would have the government finance all spending by issuing money that is returned when taxes are paid. A budget deficit would lead to net money creation, while a budget surplus would reduce the outstanding money supply. Friedman proposed that a balanced budget should be achieved only at full employment – with countercyclical deficits (‘fiscal policy’) as well as countercyclical movement of the money supply (‘monetary policy’) combining as powerful automatic stabilisers.

Beardsley Ruml (a New Dealer, Chairman of the Federal Reserve Bank of NY during the Second World War, and the ‘father’ of income tax withholding) argued that taxes had become ‘obsolete’ as a source of revenue for the federal government, and instead should be used to stabilise the purchasing power of the dollar (among other purposes, including income redistribution) (Ruml 1946a, b). According to Ruml, the budget deficits of the Second World War had shown that government spending is not revenue-constrained, but rather should be limited only when it threatens to spark inflation, and that a central bank can keep interest rates as low as desired no matter how large the government debt ratio becomes.

The similarities among these arguments, advanced by individuals with quite diverse perspectives, seems to indicate that such views were pervasive in the early post-war period – although by the 1970s the economics profession had returned to more conventional views on government finance (likening the government’s ‘budget constraint’ to that of a household), and by the 1980s policy-makers had come to see budget deficits as problematic.

Minsky (1986) taught that the early post-war period was stabilised by the growth of ‘big government’ (the US government’s share of GDP rose from 3% at the time of the Great Depression to an average of 20–25% in the post-war period) and the ‘big bank’ (a more active Fed intervening to stabilise interest rates and as lender of last resort). In his view, a large outstanding government debt actually promotes financial stability because it fills private portfolios with safe earning assets. However, he warned that the relative stability would (eventually) promote greater risk-taking as memories of the calamity of the 1930s faded; as he put it, ‘stability is destabilizing’. Hence, behavioural changes in the private sector would gradually transform the financial structure from ‘hedge’ (the safest, where income flows are expected to be sufficient to make all payments as they come due), to ‘speculative’ (where only interest could be paid – principal could not be retired), and finally to ‘Ponzi’ (interest would have to be capitalised – the debtor borrows to pay interest). Financial crises would reappear and become more frequent and more severe.

Minsky argued that expansions that are led by government spending, and in which consumption is financed out of income flows generated in a high-employment society, are more sustainable than are expansions led by private sector investment or debt-fuelled borrowing. Godley (1996) developed a simple but highly instructive sectoral balances approach along a similar vein. At the aggregate level, if one sector runs a deficit (spending more than its income), then by identity at least one other sector must be running a surplus (spending less than income, and accumulating claims on the deficit sector). In a closed economy, the private sector can run a surplus (‘saving’) only if the government sector runs a deficit; the debt of the government sector equals the net accumulation of financial assets (‘net financial saving’) of the private sector. Allowing for a current account deficit means that the government’s budget deficit needs to be larger – the sum of the current account deficit and the private sector surplus will equal the budget deficit. This adds weight to the arguments of Minsky, Lerner and Ruml that pursuit of a balanced budget can be counterproductive – especially for a nation like the USA that runs trade deficits. A balanced budget policy would mean, by identity, that the USA’s private sector would run chronic deficits and dig itself deeper into debt. (This is precisely what happened in the decade leading up to the global financial crisis – see Godley and Wray (1999) as well as Tymoigne (2014a).)

Most of these traditions were largely lost over the final four decades of the twentieth century. The Chartalist approach to money never gained much of a foothold, with economics textbooks continuing to propound the barter approach to money. Indeed, money became increasingly unimportant in sophisticated economic theory – at most, serving to lubricate market exchange, and having little to no ‘real’ impact in most macroeconomic models. In the late 1960s, microeconomic theory of the consumer’s budget constraint was adapted as a government budget constraint – with government choosing to finance its spending through tax revenue, borrowing by issuing bonds or printing money. Borrowing could drive up interest rates (crowding out investment) and expose government to default risk; printing money raised the spectre of inflation (or even hyperinflation). Minsky’s warnings of the potential for financial crisis were largely ignored; indeed, by the 1990s and 2000s, the ‘era of the Great Moderation’ had supposedly arrived, a period of diminished risk and greater stability. Godley’s sectoral balance approach never gained many adherents – while economists and policy-makers clamoured for government budget surplus and simultaneously for more private saving (an impossible combination except for current account surplus nations). The only stream of research that did make headway was the endogenous money approach, as policy-makers abandoned money targets in favour of interest rate targeting (albeit in the guise of a Taylor rule to control inflation).

However, MMT used these foundations to build a robust approach to macroeconomics. Beginning in the mid-1990s, MMT developed a large following over the next two decades especially after the growth of the ‘blogosphere’, which helped to spread the ideas outside academia. MMT’s standing was also increased by the global financial crisis after 2007 as well as the entrenched euro crisis that began a couple of years later because its proponents had long warned of the likelihood of each (for an early warning, see Godley 1992; for analysis of the crisis see Wray 2009, 2012).

We will explore the main policy implications in the following section.

Policy Implications of MMT

MMT follows in the tradition of those early post-war economists who recognised that sovereign government cannot run out of its own currency. As such, government faces an inflation constraint, not a solvency constraint. MMT also adopts the Knapp–Innes–Keynes–Lerner view that the state chooses the money of account, imposes taxes and other obligations in that unit, and issues the currency that it accepts in payment of those obligations. For that reason, government must spend first before it can collect taxes. Government’s net (deficit) spending allows the nongovernment sector to run a surplus (net financial saving), accumulating claims on government. These claims can take the form of currency, bank reserves held at the central bank or bonds issued by the treasury.

If government floats its currency, it maximises its domestic fiscal and policy space. It can formulate its spending and tax policy to pursue domestic policy goals such as full employment, price stability and rising living standards. It can also set its interest rate target consistent with those goals and with achieving a desired distribution of income between creditors and debtors. Government might instead choose to manage its exchange rate along a continuum between loosely held ceilings and floors on one end to a tightly held peg with a promise to convert on demand at a fixed exchange rate at the other end. A managed exchange rate regime reduces domestic policy space; a peg opens the possibility of default on the promise to convert and exposes the government to speculative attacks and currency crises.

MMT has made major contributions to our understanding of the coordination of fiscal and monetary policy. In modern nations, the monetary and fiscal policy functions are divided between the central bank and the treasury. While it is often claimed that central bank independence is desirable (the claim is that this enhances the central bank’s ability to fight inflation, as it can supposedly refuse to allow the treasury to ‘money finance’ spending), in fact the central bank and treasury must closely coordinate their operations. The modern central bank makes and receives payments for the treasury, clearing payments between the treasury and private banks (while also clearing payments among private banks and acting as lender of last resort). Since central banks operate with an overnight interest rate target, and since these daily payment flows are huge, the central bank always accommodates payment system needs for reserves. For a discussion of the necessity of central bank intervention to keep rates on target, see Forstater and Mosler (2005, p. 539) who argue:

In a state money system with flexible exchange rates running a budget deficit – in other words, under the ‘normal’ conditions or operations of the specified institutional context – without government intervention either to pay interest on reserves or to offer securities to drain excess reserves to actively support a nonzero, positive interest rate, the natural or normal rate of interest of such a system is zero.

In modern systems, the central bank either pays interest on reserves or offers interest-paying treasury bonds as an alternative to reserves. Since the treasury is by far the largest economic entity in any modern economy, its fiscal operations have huge impacts on daily payments flows that must be offset by central bank operations. So while the central bank may have substantial discretion in choosing its interest rate target, its monetary operations cannot be formulated independently from treasury operations (Fullwiler 2011; Tymoigne 2014b).

MMT recognises the symmetry between the post-Keynesian view that bank loans ‘create’ deposits, which then leads to the creation of reserves as the central bank accommodates demand, and the Chartalist view that government must spend before it can collect taxes. Bank deposits are the liabilities of banks, and must be created when the bank makes a loan; central bank reserves are the liabilities of the central bank and must be created when the central bank either lends reserves to banks, or purchases assets (such as government bonds) from them; and currency is the liability of the government that must be created by government as it spends. Only once deposits are created can debtors to banks use them to make payments; only after reserves are created can banks use them to repay loans to the central bank, or use them to buy government bonds; and only after currency has been created can taxpayers use it to pay taxes and other obligations to the state. Today these operations occur on balance sheets as electronic entries and debits. Banks cannot run out of deposits; central banks cannot run out of reserves; and sovereign governments cannot run out of currency. This symmetry is hidden in most analyses of fiscal policy behind the veil of central bank independence and government budget constraints. If economists understood the coordination of monetary and fiscal policy operations, they would understand Ruml’s claim that ‘taxes for revenue are obsolete’.

Another area on which MMT has focused is policy to achieve and maintain full employment with wage and price stability. Following Minsky (1965), MMT adopted the ‘employer of last resort’ or ‘job guarantee’ proposal in which the national government provides wages to fund a programme that would offer a job to anyone who wants to work (Tcherneva 2014; Mitchell and Wray 2005; Mitchell and Muysken 2008; Harvey 1989; Forstater 1999; Wray and Forstater 2004; Mosler 1997–98.) The universal job guarantee was part of Martin Luther King’s proposal to reduce inequality and ‘depression-like’ unemployment suffered by African Americans even during the business cycle upswing of the 1960s. For example, see Forstater (2002, p. 45), who argues:

The Rev. Dr. Martin Luther King, Jr. wrote extensively on economic matters, especially unemployment policy. King supported a federal job guarantee for anyone ready and willing to work. He believed it would provide employment and income security, as well as increased public and community services… His policy proposals are just as relevant today as they were when they were first put forward some forty years ago.

While there are various versions of the proposal, most of MMT’s followers advocate a universal programme that would offer a uniform basic wage plus benefit package, taking workers ‘as they are’ and ‘where they are’ – creating jobs in every community and tailoring them to the skills and educational level of workers. The programme could be decentralised, with projects formulated and managed locally (by local governments, school and park districts and not-for-profit community service organisations), but with funding from the central sovereign government (the only entity that can afford an open-ended offer to hire anyone who wants to work). The projects would provide skills and training upgrading on the job and would generate output useful to the community.

Unlike for-profit business, because the programme would not have to operate according to profit-maximisation criteria, it could pursue other goals, such as the creation of ‘green jobs’ and promoting social, environmental, economic and financial stability. It would also provide a powerful automatic stabiliser – with government spending on wages in the programme rising when the private sector slows, and falling when the private sector heats up. Private employers would recruit from the programme’s pool of labour, which would act like a buffer stock to help stabilise wages (and hence prices). MMT’s proponents argue that this ‘reserve army of the employed’ will function much more effectively than a Marxian ‘reserve army of the unemployed’, as it would allow workers to preserve and even upgrade their skills rather than becoming unemployed whenever the private sector downsizes. In a slump, the programme would prevent wages from falling below the programme’s wage, helping to stabilise consumption. In this way, the programme helps to maintain the advantages of private market flexibility even as it maintains full employment and reduces fluctuation of aggregate demand. As Forstater (1998, pp. 562–3) put it:

Full employment and even high employment and capacity utilization rates are associated with structural rigidities related to a number of undesirable consequences. For this reason, central banks, national governments, and international organizations have resisted policies that would promote full employment. What has been almost entirely overlooked, however, is the ways in which the selective use of discretionary public employment might promote higher levels of employment without the loss of system flexibility. A primary reason for overlooking the advantages of public employment has been due to the tendency to evaluate public sector activity by the same criteria that private sector activity is evaluated. But public sector activity serves a different purpose than private sector activity and so should be evaluated according to different criteria. The public sector is not constrained by the same competitive pressures as the private sector, and therefore it has a greater degree of latitude in choosing what activities to engage in, what methods of production to utilize, and where to locate its activities. These characteristics of public sector activity may be utilized to promote higher levels of employment without resulting in rigidities of the production system normally associated with high or full employment. In addition, these same features may also enable these higher levels of employment without undesirable environmental impacts or geographic dislocation of workers.

MMT was an early critic of the setup of the European Monetary Union, arguing that the attempt to divorce monetary policy formation (in the hands of the ECB) from fiscal policy (which remained within the purview of the individual member nations) was a mistake. More specifically – as Goodhart (1998) put it – the EMU was the first major deviation from the ‘one nation, one currency’ rule that we find going back through history and around the globe today. The creation of the EMU was a conscious attempt to eliminate what we have called here sovereign currency, with each member nation adopting what was essentially a foreign currency. As currency users (not issuers), spending by member governments would be limited to their tax revenue plus ability to borrow euros. They became somewhat analogous to US states or Canadian provinces – ultimately relying on the willingness of the ECB to stand behind their governments’ debts.

MMT followers warned that the first serious financial crisis and deep recession would cause budget deficits to rise, triggering credit downgrades and higher interest rates on debt. Facing default, member nations had to turn to the ‘Troika’ which imposed austerity as a condition of lending. As Godley (1992) had feared, loss of their own fiscal sovereignty would reduce members to the status of colonies. By 2015, these fears had been validated – at least in Greece. Many came to see the solution to the euro crisis as requiring reconnection of fiscal policy and currency sovereignty, either for the union as a whole or through dissolution of the EMU and restoration of national moneys (Mitchell 2015).

Conclusion

MMT has synthesised a number of themes that can be traced back through the history of economic thought, but which had largely been lost over the past half century as economics turned toward increasingly sophisticated mathematicised models that downplay the role of money and financial institutions. In place of detailed analysis of the coordination of monetary and fiscal operations, most economics supposed ‘money drops’ and ‘government budget constraints’. The importance of fiscal sovereignty was ignored – or dismissed – as many pushed for ‘optimal currency areas’, currency boards and dollarisation or euro-isation. Rather than considering the historical evolution of money and financial institutions, simplistic stories of the transition from barter to commodity money focused attention on money’s role as a medium of exchange. While that is, of course, an important function of money, it has little to do with most of the financial innovations that led up to the global financial crisis after 2007. MMT has tried to recover the messier but more revealing traditions that have survived on the fringes of the discipline. Much remains to be done to make monetary economics relevant to the real world.

See Also