Sunday, 20 February 2011

An introduction to Modern Monetary Theory.

Note. Introducing Modern Monetary Theory in less than 2,000 words or so is not easy. I tried here some time ago here. The article below is another attempt. This summary hopefully reflects the views of most MMT advocates, but it should not be taken as necessarily being an accurate reflection of their views. It’s “MMT as I see it”.


MMT consists essentially of a simple solution to a series of complex economic problems. These are the problems which economists and politicians are currently grappling with: deficits, national debts, inflation, unemployment and so on. Or to be more accurate, MMT is a step forward in solving those problems.

But MMT itself has a big problem: it is so simple that at first sight, it is often rejected precisely because it is so simple. But then E=MC2 is a simple formula. That doesn’t stop Einstein’s theory solving dozens of problems in physics and astronomy.

Anyway, MMT says basically that given excess unemployment, the government / central bank machine should just create more money and spend it. And conversely, given excess inflation, government should do the opposite, that is rein in money (e.g. via increased tax) and “unprint” or extinguish money.

Also, MMT claims that government borrowing is largely a waste of time. That is, the traditional Keynsian policy of having government borrow and spend more in a recession is defective. So in a recession, governments should simply spend more – and forget about borrowing.(For more on the nonsense that is government borrowing, see here.)


Now the knee jerk reaction of 99% of population to the money creation idea is entirely predictable: “inflation”.

However the fact of creating new money does not, repeat not, cause inflation. For example if someone prints a million tons of $100 bills and hides them down a disused mine shaft, there’d be no effect. It’s only when that money is SPENT, that there is an effect, and the effect is to raise demand, which is exactly what is needed in a recession (as long as the increase in demand is not excessive).

As regards inflation, employers do not raise prices unless they find demand for their products EXCEEDS their ability to supply. And if an economy has spare capacity, particularly excess unemployment, then employers CAN meet the extra demand. Thus little inflation is caused by a “print money and spend it” policy in a recession, as long as the amount printed or created is not excessive.

As distinct from the short term, it is possible that the additional money will EVENTUALLY lead to inflation. Well the answer to that was spelled out above, namely that if inflation DOES loom, then the “money printing” process can be put into reverse. Plus there are other and more conventional anti inflationary measures government can take: raised interest rates for example.

Public v. private sectors.

A second possible objection to the above money creation idea is that it increases the proportion of GDP taken by the public sector. That’s a fair point. And there is a simple solution. This is to use part of the new money to reduce taxes, i.e. just leave peoples’ hard earned money in their pockets. Some of that money will then be spent on private sector goods.

As to evidence that households really do spend a significant proportion of windfalls deriving from tax reductions and other sources, see here, here, here and here.

Having dealt with the objections to MMT, I’ll now explain a few more of the advantages.

Crowding out.

First, the total AMOUNT of new money that needs to be created to bring about a given reduction in unemployment is guaranteed to be less (and could be VASTLY less) than the amount of borrowing needed under the conventional “borrow and spend” policy. The reason is that government borrowing increases interest rates which in turn crowds out private sector economic activity.

There is much argument as to the EXTENT of this crowding out, but it is just possible that the above borrow and spend policy has no effect whatsoever as far as reducing unemployment goes, because the crowding out is total.

Or possibly the crowding out is say 90%, in which case government needs to borrow and spend about NINE dollars for every ONE DOLLAR increase in GDP: a complete farce. Noticed the HUGE increase in government borrowing over the last two years combined with a less than dramatic reduction in unemployment?

Of course (and here comes the real farce), governments don’t actually let interest rates rise in a recession. That is, they buy back government debt, i.e. they engage in quantitative easing, or “money printing” of a sort. So the REALITY is that governments are currently implementing MMT, but in an illogical and incoherent manner.

So what exactly are the illogical aspects of our current “MMT on the sly” policies that need to be removed to make it more logical?

Well let’s consider the BASIC purpose of the economy. It’s to provide what the consumer wants, isn’t it? Thus MMT implemented in a logical way simply consists of enabling consumers to purchase more, and that is easily done, as mentioned above, by leaving money in household pockets, rather than confiscating such money via tax. And that can be done for example via a payroll tax reduction and various other measures. (Plus, as mentioned above, public sector spending can be increased.)

In contrast it is very hard to be sure who are the main beneficiaries under a traditional Keynsian “borrow and spend” policy. Under this policy, government borrows money, then spends it, plus it issues bonds to those it has borrowed from. Then it buys back some of the bonds, i.e does some QE. Who benefits from this process? Just try working it out yourself. You’ll probably never get to the bottom of it. Certainly a major effect of Q.E. is to boost asset prices, the stock market in particular. And the main beneficiaries here are the wealthy.

Also, politicians have recently channelled new money into the pockets of Wall Street, rather than Main Street. After all, if you are a politician and some banker has funded your election campaign, you have to pay them back, don’t you?

Is MMT better than interest rate adjustments?

For decades the main tool for adjusting demand has been interest rate adjustments. Thus it is valid to ask why MMT is better. There several reasons. Here are just a few.

First, interest rate adjustments are distortionary: they bring sudden and temporary windfalls for people and business heavily reliant on borrowing, while for others there is little or no benefit. Indeed, savers actually LOSE income as a result of rate reductions.

Second, several studies into interest rates have concluded they are an ineffective way of influencing demand. For example the Radcliffe Report on monetary policy in the U.K. published in 1960 concluded that ‘there can be no reliance on interest rate policy as a major short-term stabiliser of demand’.

Third, the interest rate, that is the price of borrowed money, should be determined the same way as everything else: by market forces. Having government tinker with the price of something is justified given some very good explanation, and assuming there is no alternative to “tinkering”. But there is an alternative to tinkering with interest rates: it’s called MMT.

To summarise, where a government needs to stimulate an economy (or do the opposite – damp down economic activity), there is a way of doing so which is much simpler than existing policies. This simple alternative is MMT. Moreover, governments are already implementing MMT, but in a chaotic and illogical manner.

MMT would make national debts obsolete. MMT would cut out a lot of nonsense, bureaucratic expense, subsidies for the rich, and so on: the list is quite long.

The history of MMT.

Given that the first “M” in MMT stands for “modern” you might think MMT is a new idea. Actually it is several decades old, which makes the title “Modern Monetary Theory” not entirely appropriate.

There is actually an alternative name: “Functional Finance”, but the name “MMT” seems to have gained the upperhand. The word “functional” is very appropriate. The idea behind this word is that there is no reason why government spending needs to equal the total of government income from tax and from borrowing. That is, the purpose of government income and spending should be “functional” in the sense that the only important consideration is the effect of such income and spending on unemployment and inflation.

Keynes was well aware of the essentials of MMT, while a contemporary of Keynes’s, Abba Lerner, advocated MMT in a more open and blunt manner than Keynes. Also, Milton Friedman advocated what amounts to MMT here.

Thomas Edison.

But perhaps pride of place should go to Thomas Edison, the inventor, who tumbled to a couple of the essential ideas behind MMT in 1921. Edison certainly gets the idea, mentioned above, that government borrowing is a nonsense. Plus he gets the idea that any new money should be the property of the people, not of bankers, the rich, or any other group.

Alternatively, see the original New York Times article where Edison sets out his ideas. See the two paras near the end starting “It is absurd to say..”. (Incidentally, Edison in this article also spots the basic flaw in the gold standard! Not bad for a non-economist. But then he was a genius, as we all know.)


  1. In terms of ideas not being new, it is interesting to read excerpts from the book 'Post War Banking Policy' by the Right Hon. Reginald Mckenna PC who was UK Chancellor of the Exchequer in the Asquith government of 1915-1916. It is a collection of speeches given to bankers of the time.

    "I'm afraid the ordinary citizen will not like to be told that the banks or the Bank of England can create or destroy money. We are in the habit of thinking of money as wealth, as indeed it is in the hands of the individual who owns it..."

    "At the risk of wearying you with a discussion of a process with which you are probably thoroughly familiar, let me give you a brief illustration of how bank deposits are increased by bank loans"

    So the banks were familiar with the true operations a century ago.

  2. Neil, Thanks for that. Plus one can go back much further to find people discussing the stuff we are currently discussing about banks. Huerta do Soto’s book “Money, Bank Credit, and Economic Cycles” deals with Spanish and Italian banks in the middle ages. See his 2nd and 3rd Chapter. The book is downloadable for free here:

    Plus they had a credit crunch in Ancient Rome and dealt with it sharpish by Keynsian or Lernerian methods: opening the Treasury and distributing money to all and sundry. You have to wonder whether we’ve learned anything in the last 2,000 years!

  3. Thanks for this Ralph. Very useful.

    Could you say more in a future post about how MMT is affected by the independence or quasi- independence of the central bank from the treasury? Also, what specific policies or targets should a central bank implement if it is to make its decisions in accord with MMT. What metrics should be used to determine whether more or less money creation is necessary?

  4. Dan, By coincidence your queries are answered to some extent in the 2nd half of a post I did today, 23rd Feb, "If Mervyn King....."

  5. Ralph, this is what I'm looking for, a simple overview of MMT. But I have a question about one paragraph:

    Anyway, MMT says basically that given excess unemployment, the government / central bank machine should just create more money and spend it. And conversely, given excess inflation, government should do the opposite...

    Yes. But the question is: What does MMT say, when the problem is excess unemployment and excess inflation at the same time, as has been the problem, in the U.S. at least, since the stagflation of the 1970s. ?

    Art S

  6. Arthurian, MMT does not have a magic cure for stagflation, at least not that I know of. The only solution is the “Paul Volker” solution, that is an extended period of deflation (in the low aggregate demand sense of the word), during which inflationary expectations and inflation itself will hopefully subside.

  7. Ralph,

    I think MMT could be summed up in one sentence.

    "MMT believes that governments should create new money for the public good, and only use taxation as means of curbing inflation".

    Is this basically correct, or not? Your expert opinion requested.

  8. My project in development may be of interest too

    Robert Searle.

  9. Anon,

    Trying to sum up MMT in one sentence is a bit of a challenge. I’d sum it up thus.

    In a recession, the government / central bank machine should print new money and spend it into the economy as tax cuts and/or public spending increases, and conversely, given looming inflation, the “machine” should do the reverse, i.e. raise taxes and withdraw money from the economy.

    If by “public good” you mean public expenditure (e.g. on education, infrastructure, etc) then the phrase “public good” should not be in the sentence because MMT is apolitical: is puts no view on what public spending should be as a proportion of GDP. Indeed, nor should any economist because the latter proportion is a POLITICAL question.

    For Abba Lerner’s summary of the above point see para starting bottom of p.39 here:

    However, there are parts of that Lerner paper I don’t agree with.

  10. Ralph,
    Thank you for your informed reply. I have been informed though that little, or indeed, NO taxation may be necessary in MMT. In the latter instance, tax is only reintroduced as a means to control inflation? I was informed of this by a "follower" of Abba Lerner? Did he propose such a thing? RS.

  11. Yes, after careful examination of Functional Finance Abba Lerner does indeed suggest that there can be periods of "Zero Taxation", and is only reintroduced to ensure that excess money can be taken out of the economy. For him, taxation is indeed not a means for raising expediture but is essentially a kind of "inflation tax."

    John Gelles was very keen on Functional Finance, and the above approach.

    The following comes from

    Based on effective demand principle and chartalism, Lerner developed functional finance, a theory of purposeful financing (and funding) to meet explicit goals, including full employment, no taxation designed solely to fund expenditure or finance investment, and low inflation

    It would nice if Ralph can confirm the above (with refs) as I am researching a book on monetary reform.

  12. Ralph,
    I would be grateful to your reply on the last message. I should add that I have put a link to this page on my site for sometime on my entry on Transfinancial Economics.In other words, I am doing you a small favour as people maybe attracted to your blog if they click on for any reason.

  13. IANA economist, and I have a question about the following.

    "As regards inflation, employers do not raise prices unless they find demand for their products EXCEEDS their ability to supply."

    Does this remain true even in the decadent stage of late capitalism? I remember Joseph Heller gave a reading in the 80s in which he quoted with relish from a news story to the effect that due to poor sales GM was forced to raise prices. That kind of thing is even more common in the digital age with prices of music, movies, and ebooks being set with little regard for supply issues.

    1. Good point. I.e. employers often succeed in raising prices even when there is no excess demand. However, price increases really TAKE OFF when there is excess demand.

      As to how to re-phrase the offending sentence, I think the word “excessively” needs inserting after “prices”.

  14. MMT has an error in the way it thinks about bonds. When I fix this error, the risk of hyperinflation becomes very clear.


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