Friday, 16 April 2010

A primer on Modern Monetary Theory (MMT)

Modern Monetary Theory (MMT) is an attempt to explain how 'money' comes about in a way that is different to classical economic theory. If true it shows that the way the government runs the financial part of the economy is inefficient and that we actually have much more flexibility to get us out of the current recession than we are using. Scary stuff.

Economies out there like Japan and the US are not behaving as classical money theory suggests they should. Our own government has issued £375 billion of new currency and nothing much happened. The data is suggesting strongly that we don't understand what is happening. Perhaps MMT explains it. At the moment I don't know.

Please read:
Deficit spending 101 – Part 1

Deficit spending 101 – Part 2

Deficit spending 101 – Part 3
Then read:
Will we really pay higher taxes?

Will we really pay higher interest rates?
Then read:
Fiscal sustainability 101 – Part 1

Fiscal sustainability 101 – Part 2

Fiscal sustainability 101 – Part 3
Then read:
Functional finance and modern monetary theory 


Some more stuff here:


The good Professor Scott with a primer on the operational realities of the monetary system
My own How the government's super platinum credit card works


An interview with Professor Bill Mitchell in the Harvard Review, gives an excellent overview of MMT


Tom Hickey said...

I found a reference to MMT in a comment somwhere about a year ago. At first, I was tempted to blow it off as ridiculous, but references were provided and I checked it out. It blew my socks off. Suddenly the sclaes were lifted from my eyes and I began to see. I gradually becamse accustomed to the light as a continue to study this, and now I am convinced it is the holy grail of finance, macro, and political economy.

These are the chief bloggers on MMT:

Marshal Auerback

Scott Fulwiler

Bill Mitchell"

Warren Mosler


L. Randall Wray

There are also a number of working papers by these and others writing in the field that are available (free) at

The Levy Institute

and the

Center for Full Employment and Price Stability

The "bible" of monetary economics is Wynne Godley and Marc Lavoie, Monetary Economics (2007)

Neil Wilson said...

That would be Monetary Economics: An Integrated Approach to Credit, Money, Income, Production and Wealth

Lord Keynes said...

Nice collection of links - Neo-chartalism and MMT are indeed insightful perspectives on modern monetary systems.
I have a great deal of sympathy with the approach, but under the present system of liberalised capital accounts, countries with current account deficits might be limited in how far they can run their economies along MMT lines.

Maybe I am wrong - I would like to think so, but I suspect you need a return to discretionary capital controls and an completely new and reformed IMF that actually steps in and rescues countries facing Forex shortages with US dollars or special drawing rights given without any strings attached (that is, no brutal deflationary policies).
In such a world, MMT would be easy to implement.

Tom Hickey said...

Lord Keynes, you may want to bookmark Warren Mosler's site, The Center of the Universe, or subscribe to the RRS feed. Warren is an expert on international finance from the MMT perspective, and there are a number of excellent commentators there as well. These are the kinds of things that come up, and questions/objections are welcomed.

Musgrave said...

Neil Wilson says “Our own government has issued £275 billion of new currency and nothing much happened. The data is suggesting strongly that we don't understand what is happening. Perhaps MMT explains it. At the moment I don't know.” I suggest the explanation is roughly as follows.

Most if not all of that £275bn is just quantitative easing, described by Mish as “quantitative nothingness”. Why should QE have much of an effect? Darned if I know. Reason is thus.

Owners of bonds regard those bonds as part of their SAVINGS. If those bonds are converted to cash, they are not going to run out and spend the cash on wine, women and song. The cash will just be plonked in banks, and/or will push up the price of other assets.

Doubtless QE has a finite effect, but it won’t be a big effect.

Another point is that the UK is a very small part of the world economy, thus there is a limit to how much stimulus it can effect without its balance of payments turning into a disaster zone. Plus UK inflation at the time of writing is too high. The US is in a totally different position: US inflation is well below UK inflation, plus the US is bigger chunk of the world economy. The US could perfectly well effect far more stimulus (MMT style or non-MMT style) and millions of jobless folk would find work.

Tom Hickey said...

The idea is that QE will "stimulate spending" by injecting greater liquidity. I also doubt very much that the central bankers think that the ex-bond holders are going to spend on "wine, women and song."

What they are hoping is that the liquidity will flow to propping up sagging asset prices, especially housing. Housing is key in a developed economy, and housing values and new construction are economically determinative.

Won't work. Savvy people don't buy into declining housing markets. That liquidity will either just sit waiting on opportunity or flow into some other financial assets. It will just reduce interest payments, possibly cutting further into demand.

Neil Wilson said...

"Owners of bonds regard those bonds as part of their SAVINGS."

I'm sure that's a myth. Bonds are generally held by financial institutions - mostly as backing for pension payments.

I would suggest that when banks hold them as a 'slightly better than cash' option they see them as part of their capital - just like the equivalent cash deposit. And that means they can (and will) lend against them.

Musgrave said...

Neil: I agree that where bonds are held by households, this is usually via institutions like pension schemes. But assets held by the latter are very much SAVINGS, rather than “money to be splurged in the next week”. Thus these bonds in effect held by households ARE savings.

Re turning bonds held by a bank into cash, that would not affect the bank’s capital (as I understand it) but it WOULD boost the bank’s reserves. However, reserves are irrelevant to a bank’s decision to lend, as Bill Mitchell has pointed out dozens of times. Banks lend when they see a profitable lending opportunity. Later on, and if necessary, they borrow reserves from other banks, or if the banking system as a whole is short of reserves, the bank system in effect forces the central bank into issuing more reserves (if the latter wants to maintain control of interest rates).

Much the same point applies to capital, except that coming by extra capital is a slower process than coming by additional reserves. There is a nice example of this taking place at the moment in that banks are in the market for extra capital as a result of the new Basle rules.

Neil Wilson said...

My point is that there is no difference between cash and bonds.

Cash is a stock unless it is currently being used for a transaction.

The idea that because it is cash it somehow must be being spent is a myth.

Daniel said...

Thanks for putting this collection of links together (most of which I've read more than once already)...i was just about to do it myself and now I don't have to! I really like that you presented this as a description, without the policy suggestions attached to it. They need to be decoupled --- for example, Bill Mitchell would find a larger audience for his excellent descriptions of the system if he would clearly delineate that the "full employment" normative theory that he espouses is his own suggestion as to the optimal way to improve the real economy, but that even if one does not agree with that prescription, the description of daily operations of the Fed/Treasury/economy from MMT is accurate (and thousands of macro-econ textbooks are, sadly, not).

Andrew said...

If there is no difference between cash and a bond then there is no difference between cash and a term deposit.

And in reality your cash is your savings.

However is there a difference between being a saver and a spender? Both could have the identical amount of savings.

So the issue here seems related to velocity of money. I think it would be true that if you buy a bond even for a few hours your intention is not to spend but is rather to do the not spending act of saving.

So all of these money forms are savings. But it the intension of the owner that seems the relevant factor.

A pensioner for example can intend to save. And in aggregate regardless of the ability of term deposits to be spent pensioners are savers even if they are spending their savings a little each day.

So a bond holder is a saver not needing the cash.

Anonymous said...

Well Neil!! Its official....The debate about "Money creation and society" will be had in Parliament on November the 20th...perhaps you underestimated the Positive Money Team? Now that Martin Wolf is determined to go down the path of public money creation, also lord adair has admitted its technically the best method of creating money, also mervyn king is said to be supporting PM; will you still hold onto the belief that money must be created as debt?

Neil Wilson said...

Money is always created as debt. That is how it works. We all create debt all the time. You create money as debt every time you pick up a loaf of bread in a supermarket.

You can reduce the amount that private banks lend and do more government spending/tax cuts. But that is just the government doing the 'borrowing' rather than private individuals. It's still debt.

And we can do that in the current system. MMT suggests that we ban certain lending - such as lending for currency settlement. That is so much more effective than the elaborate illusion put forward by PM which tries to do it via the pricing mechanism. That's a 'faith in markets' approach which won't work and will likely tilt the lending market even more towards financial pawnbroking games rather than productive investment.

PM has put forward bills in parliament before. They are very good lobbyists, marketeers and showmen. But just reading what they put forward last time showed that they were systemically naive and pushing an elaborate illusion rather than anything that will actually work to fix the problems we have - lending on the wrong things.

Its very sad that we have to waste so much time on something so elaborate when there is a much simpler solution. But no doubt we'll have to learn the hard way that it doesn't work - just like the austerity illusion.

Anonymous said...

Mr. Wilson,

I think there is a problem with MMT I have read about that you would be able to grasp easily.

They leave out non-financial assets and liabilities and say they account for financial assets and liabilities. Isn't that is cooking the books?!

To be specific non-financial assets include tangible assets, houses, furniture, cars, planes, tools, factory equipment, intangible assets, patents, copy rights. Real world stuff. All the above accountants account for. But but not MMT.

How come they claim to have balanced transactions and books?

Well they ignore the entity concept in accounting. Each entity has their own books. When entities trade with each other one's debit is the others credit and visa versa. So, one transaction between entities has at least 4 etries. At least two entries in both entities books.

In mmt book cooking if a perfect counterfitter came to town and exchanged finacial assets for real non-finacial assets it claimed they are richer because their financial balances were higher. And the real balances were not counted.

But, if you kept your books you would count them. A house is on your balance sheet. Your stuff has no counter party.

Most finacial assets have a counter party.

They show a banks balance sheet with depositors' accounts. Are the depositors' other real assets recorder there? No. They do not show individual entities or sector balance sheets. And again they ignore non-financial real wealth.

MMT goes against common sense. You would have to be trained as an economist to believe it.

In Zimbabwe some people were disassembling the power and signal light infrastructure and trading it for foreign paper. That real stuff left the country in a depreciated state. Did they get richer as a group? Did Zimbabwe and the trade partners get ritcher as a group?

Neil Wilson said...

MMT doesn't leave out the real stuff at all. It uses the National Accounts which includes all that.

MMT is about the financial circuit and how that is connected to the real circuit inductively. It's a theory of money so naturally it tends to focus on the financial circuit.

Stuff does have a counterparty in accounting. It is called 'equity'. So if you have a house, then the counterparty on your balance sheet is the equity in that house denominated in whatever financial asset you choose to draw the balance sheet up in.

That's how it can be used as collateral for a loan in that financial asset.

You hand a charge over what the house 'owes' you in a particular financial denomination to a third party. In return they create some numbers on a spreadsheet for you to play with.

The MMT analysis specifically states that exports are a real cost and the imports are a real benefit - because it can see through the finance circuit to the real stuff behind it.

That is why is suggests that export led growth isn't all it is cracked up to be. Why chase foreign tokens for their own sake? You need to be exchanging your real goods for somebody else's real goods that allows your economy to be better.

That's why it suggests a Job Guarantee that ensures that all real labour available to an economy is engaged doing something useful.

I suggest you go back to the source and start again. You have completely misunderstood what MMT is all about. It is *precisely* about informing people that they need to stop worrying about the financial circuit and start concentrating on the real stuff.

Tom Hickey said...

@ Anonymous

A key fundamental of MMT is that only constraint on an economy is the availability of real resources. Accounting is a nominal record of real resources for expediency in record keeping. It's not possible to "add apples and oranges" but it is possible to add their their nominal values in a unit of account. It's a convenience that everyone recognizes. No one thinks that the nominal values are the actual stuff, and certainly not MMT economists.

There is a condition in which real resources are tied directly to financial resources and that is when the government agrees to exchange its currency for a real resource, such as gold or silver, at a fixed rate. Then the government has to manage the currency so as not to create a condition in which it forced to obtain that resource to meet demand for conversion of government-issued financial assets into the real asset, as it obligates itself too do at a set rate. Then the government's policy space is limited in that it must first look to the availability of its real price anchor rather than at the real economy.

This is a real constraint under a convertible fixed rate monetary regime that doesn't exist under a non-convertible, flexible rate regime in which currencies float relative to each other without being legally anchored to a real asset through convertibility.

The world is no longer on a convertible fixed rate monetary regime, although some government do undertake to exchange their currency for a financial asset (other currency) that they do not issue themselves and must obtain. Of course, governments like those of the EZ that give up the ability to issue their own currency as they wish are in a similar boat. That is to say, they voluntarily limit their policy space by foregoing their sovereign right to issue their currency as they see fit.

Governments that are sovereign in their own currency and don't borrow in foreign currencies are only constrained by the availability of real resources.

On one hand, if they issue currency such that it creates demand that the economy cannot expand to meet, then the price level will rise. Then inflation becomes a financial constraint. This is a poor use of policy space.

On the other, if governments do not issue enough currency to support demand at full employment, then the economy will underperform, real resources such as man-hours will idle, and the price level may fall if demand becomes too low, resulting disinflation and possibly deflation that leads to a financial crisis as debts cannot be serviced on schedule. This is also a poor use of policy space.

A principle point of MMT is that affordability is never the issue for a currency sovereign. The challenge is to deploy available real resources to optimal advantage by not leaving resources idle, and to ensure that there are sufficient real resources available in the future for a growing population. Finance and accounting are means that serve this end.

Currency sovereigns have the policy space in which to use these means for public purpose in order to achieve the full potential of their economies for social welfare. MMT shows what these tools are and how to use them — chiefly the sectoral balance and stock-flow consistent approach to macro modeling, functional finance, and the MMT JG to resolve residual unemployment. As a macro theory, MMT is all about employing real resources for optimizing welfare and creating distributed prosperity.

How governments decide to do this is a matter of political choices. But the constraint is never "affordability," as the debt fetishists and deficit hawks claim based on the false analogy that a government is like a household or firm, only bigger. They fail to distinguish between the currency issuer and currency users.

spritrig said...

Mr. Wilson,

I made a comment referencing Cliff Notes online , "Principles of Accounting I", to provide information on the accounting points relating to MMT accounting arguments.

Those references hopfully might provide a wider and different way to look at this. Many economics programs in the U.S. do not require accounting at all. Thus many economists and people would profit by learning a little accounting. It is best viewed with an ad-blocker.

The reference comment source did not get through yet you asked me go go back to the MMT sources. I was trying to provide a reference to resources of information to others and you pointed me back to review the mmt sources, back to same point of view.

I found the flaws years ago in online articles. I do not remember the exact articles. But these articles have the same flaws.

"Paul McCulley does Modern Monetary Theory"
Figure I shows the flaws I discussed in a previous comment. It talks about surplus, but surpluses can be more than financial. Yet the graph shows only financial.
Figure and concluding paragraphs show the flawss I discussed in a previous comment. Graph only shows goods and services going between house holds and businesses. It specifically leaves out goods, services, and asset flows between the money dilluters and house holds. That is false and the reality negates or calls into queston some of the conclusions in the "What Does It Mean?" section.


Neil Wilson said...

MMT uses the *national accounts* which accounts for everything - real and financial.

The sectoral analysis is precisely the same one, to the same accounting policy, that the national statisticians prepare.

So unless you are suggesting that the entire world's accounting is wrong then you are very much mistaken in your view.

When I see phrases such as 'money diluters' I suspect that you are applying to reality a filter that curves it to your view.

Anonymous said...

My point of view along with many of the billions of people in the huge private sector arround the world is that we have borne the cost of the ravages of loss of purchasing power due to the dillution of currencies. It is not good for many of us, thus we don't apreciate it. Theories that say it is good or people using a theory to conclude it is good are hard to buy.
I have experienced the above losses and got to witness first hand a currency destruct. There are lots of problems for lots of poeple due to those losses. So, authors who say its good because of some theory contrary to peoples' experience and much history might meet disagreement.
Certain parts of the private sector are affected more than others. Which many consider unethical and/or theft. Every one, is not happy about dillution of currencies and the results.
If currency dillution, and outright purchases with printed money is not theorised as near harmless to each sectors and thus encouraged by MMT then I'm have been mistaken to have thought of MMT that way.  

Tom Hickey said...

What MMT says is that the purpose of an economy is not to enrich individuals but rather to serve as the life support system of a society. For this three factors are key. First, economic growth must be sufficient to meet the requirements of population growth. Secondly, in a monetary production economy where income from employment is a requisite for sustenance and social participation, employment of all that are willing and able to work is a necessity. Thirdly, the price level must be relatively stable as well.

Most theories of macroeconomics hold that this is a trifecta in which only two factors can be targeted and another must be used as tool. In the present view, growth and price stability are targets and employment is used as a tool, that is, a buffer stock of unemployment along with a interest rate setting iaw a Taylor rule.

MMT is the only macro theory that holds all three factors can be targeted simultaneously without using one of them as a tool, and it provides a policy prescription for doing so.

Neil Wilson said...

In a monetary economy there has to be enough money in circulation to ensure that all real output that can be created is created.

If there is any unemployment, then you are leaving real output on the table and operating inefficiently.

The primary cause of this is the paradox of thrift - savings are not spent. That means there is no effective demand signal, and things don't get made. Hence unemployment.

There are three ways to deal with that. You confiscate excess savings via taxation (i.e. money expires if not spent). You allow the economy to boom and bust so that the excess savings are destroyed in a depression - along with lots of sound capital. Or you accommodate those financial savings because they act as a voluntary tax anyway.

No other mechanism can balance the flows. You need an oil pump in the engine of the monetary economy or the oil drops to the sump and the engine seizes up.

MMT takes the third way via the functional finance approach - following from the insights of Post Keynesianism.

There are some very good pieces on how fiscal policy should be conducted linked from here