Home > Uncategorized > MMT — the key insights

MMT — the key insights

from Lars Syll

As has become abundantly clear during the last couple of years, it is obvious that most mainstream economists seem to think that Modern Monetary Theory is something new that some wild heterodox economic cranks have come up with. That is actually very telling about the total lack of knowledge of their own discipline’s history these modern mainstream guys like Summers, Rogoff and Krugman have.

New? Cranks? Reading one of the founders of neoclassical economics, Knut Wicksell, and what he writes in 1898 on ‘pure credit systems’ in Interest and Prices (Geldzins und Güterpreise) soon makes the delusion go away:

It is possible to go even further. There is no real need for any money at all if a payment between two customers can be accomplished by simply transferring the appropriate sum of money in the books of the bank 

A pure credit system has not yet … been completely developed in this form. But here and there it is to be found in the somewhat different guise of the banknote system …

We intend therefore​, as a basis for the following discussion, to imagine a state of affairs in which money does not actually circulate at all, neither in the form of coin … nor in the form of notes, but where all domestic payments are effected by means of the Giro system and bookkeeping transfers. A thorough analysis of this purely imaginary case seems to me to beworthwhile​e, for it provides a precise antithesis to the equally imaginary​ case of a pure cash system, in which credit plays no part whatever [the exact equivalent of the often used neoclassical model assumption of ‘cash in advance’ – LPS] …

For the sake of simplicity, let us then assume that the whole monetary system of a country is in the hands of a single credit institution, provided with an adequate number of branches, at which each independent economic individual keeps an account on which he can draw cheques.

What Modern Monetary Theory (MMT) basically does is exactly what Wicksell tried to do more than a hundred years ago. The difference is that today the ‘pure credit economy’ is a reality and not just a theoretical curiosity — MMT describes a fiat currency system that almost every country in the world is operating under.

In modern times legal currencies are totally based on fiat. Currencies no longer have intrinsic value (as gold and silver). What gives them value is basically the simple fact that you have to pay your taxes with them. That also enables governments to run a kind of monopoly business where it never can run out of money. A fortiori, spending becomes the prime mover and taxing and borrowing is degraded to following acts. If we have a depression, the solution, then, is not austerity. It is spending. Budget deficits are not a major problem since fiat money means that governments can always make more of them.​

In the mainstream economist’s world, we don’t need fiscal policy other than when interest rates hit their lower bound (ZLB). In normal times monetary policy suffices. The central banks simply adjust the interest rate to achieve full employment without inflation. If governments in that situation take on larger budget deficits, these tend to crowd out private spending and the interest rates get higher.

What mainstream economists have in mind when they argue this way, is nothing but a version of Say’s law, basically saying that savings have to equal investments and that if the state increases investments, then private investments have to come down (‘crowding out’). As an accounting identity, there is, of course, nothing to say about the law, but as such, it is also totally uninteresting from an economic point of view. What happens when ex-ante savings and investments differ, is that we basically get output adjustments. GDP changes and so makes saving and investments equal ex-post. And this, nota bene, says nothing at all about the success or failure of fiscal policies!

For the benefit of our latter-day​ ‘New Keynesian’ mainstream economists, let’s see what a real Keynesian economist has to say about crowding out and government deficits:

Fallacy 3
Government borrowing is supposed to “crowd out” private investment.

The current reality is that on the contrary, the expenditure of the borrowed funds (unlike the expenditure of tax revenues) will generate added disposable income, enhance the demand for the products of private industry, and make private investment more profitable. As long as there are plenty of idle resources lying around, and monetary authorities behave sensibly, (instead of trying to counter the supposedly inflationary effect of the deficit) those with a prospect for profitable investment can be enabled to obtain financing. Under these circumstances, each additional dollar of deficit will in the medium long run induce two or more additional dollars of private investment. The capital created is an increment to someone’s wealth and ipso facto someone’s saving. “Supply creates its own demand” fails as soon as some of the income generated by the supply is saved, but investment does create its own saving, and more. Any crowding out that may occur is the result, not of underlying economic reality, but of inappropriate restrictive reactions on the part of a monetary authority in response to the deficit.

William Vickrey Fifteen Fatal Fallacies of Financial Fundamentalism

It is true that MMT rejects the traditional Phillips curve inflation-unemployment trade-off and has a less positive evaluation of traditional policy measures to reach full employment. Instead of a general increase in aggregate demand, it usually prefers more ‘structural’ and directed demand measures with less risk of producing increased inflation. At full employment deficit spendings will often be inflationary, but that is not what should decide the fiscal position of the government. The size of public debt and deficits is not — as already Abba Lerner argued with his ‘functional finance’ theory in the 1940s — a policy objective. The size of public debt and deficits are what they are when we try to fulfil our basic economic objectives — full employment and price stability.

That governments can spend whatever amount of money they want is a fact. That does not mean that MMT says they ought to — that’s something our politicians have to decide. No MMTer denies that too much of government spendings can be inflationary. What is questioned is that government deficits necessarily is inflationary.

  1. August 5, 2019 at 6:19 pm

    Discussions of MMT veer between being tautologically true like saying all money is bookkeeping records with no intrinsic value, and making relatively strong predictions like any amount of monetary spending is fine.

    That is unsatisfactory. The assertion that money gets its value from having to pay taxes is questionable. It might answer why a certain currency is accepted, but it doesn’t adequately explain why it has a certain purchasing power. The practical mechanics of money creation is also poorly understood all around. What does it mean to create money and is there a “first use” benefit? Who gets it in each case (demand deposits, treasury bonds, etc). Is there a distributional effect from debt service? What are its mechanics and its limits.

    Perhaps this blog could use a series of explainer articles, and I don’t think they’d be simple or uncontroversial. Getting the record straight on bank balance sheets and demand deposits took some effort.

  2. Hepion
    August 5, 2019 at 9:30 pm

    I think understanding money is easiest if one thinks that we use 3rd party debt as money. Buyer (1st party) pays the seller (2nd party) with the debt of a 3rd party, usually government or bank.

    Then you notice how use of money is basically just a barter process, and how going into debt creates money. And, perhaps, why money does not have “certain purchasing power”; prices are always on the move because it is barter.

  3. Keynesian spain
    August 6, 2019 at 12:12 am

    “If we have a depression, the solution, then, is not austerity. It is spending. Budget deficits are not a major problem since fiat money means that governments can always make more of them.”

    Today, the countries needs commerce and the commerce needs stable exchange rates.

    If the problem is of balance of payment, more spending isn’t a solution. Post bretton Woods the crisis are of balance of payment.

  4. Ken Zimmerman
    August 10, 2019 at 2:20 pm

    In his book “The History of Money,” anthropologist Jack Weatherford points out this about money.

    “Greece was the first civilization to be transformed by money, but in a relatively short time, all cultures followed the Greeks down the same road and underwent the same metamorphosis. Humans have found many ways to bring order to the phenomenological flow of existence, and money is one of the most important. Money is strictly a human invention in that it is itself a metaphor; it stands for something else. It allows humans to structure life in incredibly complex ways that were not available to them before the invention of money. This metaphorical quality gives it a focal role in the organization of meaning in life. Money represents an infinitely expandable way of structuring value and social relationships—personal, political, and religious as well as commercial and economic. Everywhere that money went it created marketplaces. Money created a new urban geography by giving rise to towns and cities centered on the market rather than the palace. The exchange of goods necessitated new commercial routes over land and sea from one urban nodule to the next, thereby linking Greece and neighboring lands in a new web of commerce. This new social network founded on commerce and money gave rise to a new political system.” Monarchies of great empires that spread money and commercial life around the world of the middle east, and even into Europe and China.

    Weatherford also points out. “The great struggle of history has been for the control over money. It is almost tautological to affirm that to control the production and distribution of money is to control the wealth, resources, and people of the world. Over time, competitors have aligned themselves into various factions, institutions, governments, banks, guilds, corporations, religious orders, and great families; but from the minting of the first coin until today, the struggle has never abated for more than a brief respite of a century or two. The money wars have sometimes been literal ones fought on great battlefields with large armies, tanks, warships, bombers, and missiles. At other times they have been metaphorical—but no less serious—struggles conducted in private chambers, corporate boardrooms, courts of law, and legislative halls as well as on the floors of the great stock and mercantile exchanges of the world. As soon as a battle is settled in one arena, the actors and interests switch to another where they fight with new rules and new weapons. Throughout history, whenever one faction or institution seemed to have won control of money, an outside player invented another form based on a new technology, and another struggle erupted.” The term technology as used here by Weatherford includes not just what is most often considered technology – new materials like paper and metal and new devices to protect money, like magnetic strips, but also new ideas and concepts about money, such as banks, taxes, denominations, and new market designs such as the one proposed by neoliberalism.

    • Craig
      August 10, 2019 at 5:46 pm

      Excellent and very accurate post. It enumerates the many ways that the present paradigm of Debt ONLY has almost completely woven its way into the woof and warp of EVERYONE’S daily life. As mentioned in my book this is why the new monetary paradigm will have such incredibly broad and deep beneficial consequences. It will be a greater step upward than the last mega paradigm change from Hunting and Gathering to Agriculture/Homesteading/Urban Civilization. In fact one of these changes will be the ability to de-centralize urban civilization.

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