Monday, 28 June 2010

Summary of Modern Monetary Theory (MMT) ideas in four bullet points

With due deference to the creator. Thank you Tom.

"Asking for a summary of MMT in [four] bullet points for the layperson is like asking for a one paragraph summary of quantum theory. I suppose it could be done, but it wouldn’t say much that would actually help and would probably be so simplistic as to be misleading."

Modern Monetary Theory refers to the operation of the monetary system since Nixon ended gold convertibility on August 15, 1971. After that the world transitioned from a convertible fixed rate system to a nonconvertible floating rate system, which was ratified in Paris in 1973. Since then, we have been on the system that MMT describes. MMT is not proposing a new system. It is simply saying how the present regime works and shows the options based on that.

Here is brief summary of key ideas in four bullet points:

  • Under the present monetary system, the government is not financially constrained (although there are are real constraints). A government that is the monopoly issuer of a nonconvertible currency with a flexible (floating) exchange rate is not financially constrained. As currency issuer, the government neither taxes to fund disbursements, nor borrows to finance them.

  • Government expenditure increases nongovernment financial assets. Taxes simply withdraw funds from nongovernment to prevent inflationary pressure. Government deficits increase nongovernment net financial assets by a corresponding amount. The national debt is the amount of nongovernment savings.

  • A monetarily sovereign government does not finance itself with debt, and the securities it issues are bought with currency it issues. Debt simply drains excess reserves from the interbank system, allowing the central bank to hit its target rate. There is no financial reason that such a government needs to issue securities at all. It could just pay a support rate equal to the overnight rate.

  • A monetarily sovereign government as monopoly currency issuer has the sole prerogative and corresponding sole responsibility to provide the correct amount of currency to balance spending power (nominal aggregate demand) and goods for sale (real output capacity).
    If the government issues currency in excess of capacity, demand will rise relative to the goods and services available, and inflation will occur due to excess demand relative to supply. If the government falls short in maintaining this balance, recession and unemployment result, due to insufficient demand relative to supply.
    The government attempts to achieve balance through fiscal policy (currency issuance and taxation) and monetary policy (interest rates), based on analysis of data in terms of sectoral balances;contribution of government, households and firms, and foreign trade.
    MMT can be viewed as an articulation of the basic equation of macroeconomics, GNP/Y = G + C + I + (X-M), where GNP is gross national product (supply), Y is national income (demand), G is the contribution of government, C the contribution of consumer spending, I is business investment, and (X-M) is the current account balance. The rest is stock-flow consistent macro models.