Sunday, 17 July 2011

MMT Transaction Model - A Variation

As with all system modelling MMT is an abstraction - a necessary simplification of the real world so that it can be comprehended by the pathetically limited wetware of a human being.

Once you test the model against the real world and show that it is consistent with the data, then the design of the model may provide insights into the way things work in the real world (I say may because it is very easy to 'curve fit' a model which will lead you very quickly to disastrous conclusions). But it is still just a model - one of many ways of looking at the same thing. There can be variations which can provide other insights.

One of the main innovations of the MMT model is the horizontal/vertical split within a fiat currency economy. Within a vertical transaction you are operating by fiat. Within a horizontal transaction you are working with some form of private credit.

So the standard model looks something like this:
The black arrow shows the vertical system, which are less transactions in the accounting sense and more direct legal commands to the private banks to create or destroy credit - hence the term 'fiat'.

This mental model is the source of the statements that the government neither has nor doesn't have money and merely marks up and marks down private sector bank accounts. The double-entry offset account in the private bank ledger could be labelled 'Wot Government Gave Us' as easily as 'Reserves', 'Sterling' or 'Dollars'.

You'll notice there are no central banks here, no complexity, no clearing system. There aren't even any government bank accounts. It gets down to the essence of the system - the government sector can give instructions to private banks to credit entities in the economy and private banks are required to execute them.

And that's fundamentally all you need. Everything else is smoke and mirrors hiding, complicating or crippling(!) this simple operational system.

However for some this is one abstraction too many. It is too far removed from the interlocking web of structures that have emerged, wart-like, in the real economy. It's just too difficult to see. It's just too simple.

So, by way of variation, here is a different view of the system at a slightly lower level of abstraction.
Here we have a department of the government (called the 'Treasury') transacting with a bank just like anybody else. The difference is that the government owns that bank. Within the normal accepted property laws it either is, or acts like, a 100% shareholder: it sets the rules by which the bank operates, appoints the board of directors and receives distributions of any profit. It doesn't matter which sector the bank is technically part of.

In this model the private banks have an account at the government's bank as part of the clearing system. Treasury transactions with the private banks clear through these accounts at the government bank (and are offset in the private bank ledgers by a 'Wot Government Gave Us' account as before - except now it is more staidly called 'Reserves at government bank').

The only question now is how the Treasury account is handled. And that's when you realise what owning a bank really means:

  • if you own a bank then any interest charged on your overdraft or loan comes back to you as bank profit, so the net charge for borrowing is effectively zero.
  • a bank you own is not going to turn you down for a loan, 'cos if they did you'd call a general meeting and start firing people. 

So when you own a bank, and you set all the rules, your credit facility is as large as required and the cost is effectively zero. The Treasury account can go into the red and the cheques will continue to be cleared. Loans create deposits so there is no other cost to the bank from providing such a facility.

This slight variation, although still an abstraction, hopefully feels a little more familiar. A bank creates money via balance sheet expansion, and the Treasury spends the deposit created by the resulting loan. But because the government owns the bank, the Treasury loan liability and the equivalent asset of the bank cancel each other out on the consolidated government balance sheet. So overall the government still doesn't have money.