Friday, 18 October 2013

Modern Monetary Theory in 1,000 words.

Some MMTers may disagree with this “model”. Let’s see.

Plus there may not be enough detail in the following: it may need expanding to 2,000 words.

1. Government and central bank are treated as one below, and are called “government”. That does not mean that in the ideal MMT world there would be no distinction at all between government and central bank.

2. A government which issues its own currency needs to run a more or less continuous deficit. Reason is that given inflation of 2% or so and real economic growth, the national debt and monetary base will shrink relative to real GDP unless they are constantly topped up: which can only be done via a deficit. So assuming the ratio “(debt plus base)/GDP)” is to remain about constant in the very long term, a more or less constant deficit is required.

3. In a recession, a bigger deficit than normal is needed.  

4. It does not make much sense for a government which issues its own money to borrow money. Indeed Milton Friedman and Warren Mosler (2nd last paragraph) argued that governments should issue no interest yielding debt whatever. That is, the only liability they should issue should be money (monetary base to be exact).

However, if government DOES ISSUE debt, the rate of interest should be kept to a minimum – ideally less than inflation. (Warren Mosler has advocated a zero rate.) That way government actually profits from its creditors: effectively, creditors pay government to create and lodge money for them.

5. Deficits reduce unemployment for three reasons, as follows.

i) As regards public spending, the fact of government creating vacancies which the unemployed fill, reduces unemployment.

ii) As regards transfers (increased unemployment benefits, state pensions, etc), increased income for those concerned causes them spend more, which raises aggregate demand (AD).

Obviously a significant proportion of the latter increased incomes are saved rather than spent. But the empirical evidence is that a significant proportion of increased incomes is also SPENT. Thus the latter increased incomes WILL RAISE AD.

iii) Deficits increase what MMTers call “private sector net financial assets”: that’s government debt plus monetary base. And the larger is PSNFA, the higher is private sector spending: sometimes called the “hot potato effect”.

6. If there were no inflation or economic growth, there’d be a major problem with the above policy, as follows. It’s politically easy to print money and spend it, but it is politically difficult to do the reverse, that is raise taxes, rein in money and “unprint” it. And given no inflation and no growth, it would be necessary to unprint (i.e. run a surplus) as often as it was necessary to print (i.e. run a deficit).

However, given the need for a more or less constant deficit (see “2” above), the need for that politically unpopular “unprinting” would not occur often. That is, most of the time it’s a case of adjusting the deficit rather than spending as much time running surpluses as deficits.

7. If there is no government debt, or if the interest paid on it is kept a permanently low level (more or less the same thing) that implies downgrading the importance of, or abandoning interest rate adjustments as a means of adjusting AD, and placing more reliance on fiscal adjustments. That is an unconventional idea, but it makes sense because interest rate adjustments (and QE) involve channelling stimulus into the economy JUST VIA investment (and via the day to day spending of the rich). That makes no more sense than channelling stimulus into the economy just via car production and/or any other small selection of products (public or private sector).

However, there are two problems with the latter fiscal adjustment idea. First those adjustments need to be made quickly and second, they require the approval of bunch of economically illiterates known as “politicians”.

The solution is to have a clear distinction between decisions on STIMULUS, which should be in the hands of a committee of economists, and second, strictly political decisions, like what proportion of GDP is allocated to public spending, and how that spending is split between education, defence, etc.  The latter decision should of course stay with the electorate and politicians. E.g. if the above committee decided a boost to fiscal spending was needed, they’d tell politicians, who in turn would spend the money as they saw fit (bearing in mind that stimulus spending is best spread widely, as pointed out above). A system of that sort is actually already been set out here. But in any case, stimulus decisions ARE ALREADY and to a significant extent in the hands of committees of economists, e.g. central bank interest rate committees.    

Indeed, the limit to the debt ceiling which Republicans are trying to impose at the time of writing is an extreme example of the chaos that results from giving politicians a say on stimulus.

8. Expectations do not feature in the above MMT model because the empirical evidence is that expectations or Ricardian effects are feeble, e.g. see here or here . Or as Joseph Stiglitz put it, “Ricardian equivalence is taught in every graduate school in the country. It is also sheer nonsense.”

However, if the mere ANNOUNCEMENT of fiscal stimulus augments its effect, that makes little difference to the above arguments.

9. The abolition of government debt (4 above) does not stop the central bank manipulating interest rates in an emergency: it could for example simply wade into the market and offer to borrow at above the going rate.

10. Job Guarantee.

The sort of temporary subsidised employment which is popular with MMTers  (“Job Guarantee”) is not considered here.  One reason is that JG is a complicated issue which could occupy an entire book. Second while JG is doubtless a valid idea, it is essentially SEPARATE to the above monetary aspects of MMT. For example, it’s perfectly feasible to implement JG without implementing the monetary aspects of MMT. And conversely, it’s easy to implement JG type systems (e.g. America’s 1930s WPA) without implementing the monetary aspects of MMT.

10. What’s the difference between MMT and Keynes? Not much. If you like, MMT takes Keynes, cuts out the nonsense and sets out the important bits.

Afterthought (30 minutes later). I’ve also left out sectoral balances, which MMTers tend to be keen on. So perhaps the above should be entitled “The monetary aspects of MMT in 1,000 words”.


  1. "It does not make much sense for a government which issues its own money to borrow money."

    That's right. If I issue an IOU for any reason then how can I borrow it back? I could borrows someone else's IOU by swapping it for my own IOU. But there's no point in swapping my old IOU for newer IOU.

  2. " MMT takes Keynes, cuts out the nonsense and sets out the important bits".
    Unfortunately, this is only half true.
    Some prominent MMT exponents tend to obscure the message of Keynes & Lerner.
    In particular too much of MMT writing consists of
    - tedious expositions of double-entry book-keeping tautologies
    - tedious expositions of national income accounting tautologies
    - impractical political policies, e.g. Job Guarantee (mentioned in blog)
    - strange maths & confusing misinterpretations
    (e.g.Steve Keen on perfect competion and aggregate demand)

    In contrast, Ralphonomics is refreshingly clear.

    1. Re Job Guarantee, I agree that MMTers grasp of JG is hopeless: they haven’t really made any advances on the basic idea (which Pericles tumbled to in Ancient Greece 2,500 years ago) namely that in theory government can create employment for every single unemployed person. I’ve given the subject what I think is more sophisticated treatment here:

      Re the “tautologies” (i.e. sectoral balances), that’s not something that interests me much which is why I left it out of the above, but I think MMTers are right to draw attention to this subject: in particular they are right to draw attention to the fact that a government deficit equals an increase in private sector paper assets. That’s something that those suffering from debt and deficit phobia haven’t fully grasped.


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