Modern Monetary Debates

First, as a disclaimer, I must say I haven’t read everything written by economists associated with MMT. However, I think I can qualify myself as reasonably knowledgeable about the school. I did it, simply by reading the stuff that is online, starting probably two and a half years ago. No big deal…You can find books, papers, blog posts, videos. (Most of the recent criticism however doesn’t seem to care about academic work though…). Also, I would like to thank Warren Mosler (the “founder” of MMT) for being always helpful and kind concerning my doubts.

What is MMT and why the fuss about it?

Modern Monetary Theory is a school of economic thought related with the Post-Keynesian school, so it fits almost completely as a heterodox camp and therefore probably never heard off by most of economics students (and professors…).

Warren Mosler, Randall Wray, Bill Mitchell, Stephanie Bell Kelton, Scott Fullwiler, Pavlina Tcherneva are among the most important contributors to the school nowadays. Their work is inspired by previous literature of Knapp, Innes, Keynes, Kalecki, Lerner, Minsky, Godley and I should add Basil Moore.

Therefore, my short definition of MMT is a chartalist theory of outside money leveraged by a credit theory of inside money (endogenous). That infrastructure of the monetary system leads to macroeconomic impacts best described by sectoral balances (and T accounts) which could lead to financial disruptions. At the end of the day, it’s the Governments’ job to guarantee a stable macroeconomic environment, following functional finance (and being an employer of last resort).

So basically, just a bunch of monetary cranks that appear twice every century saying banks are “making money making money” and that the government must give everyone a pony. What’s the big fuss?

I guess it was probably because Alexandria Ocasio Cortez, a young American politician that has been making a splash by some of her ideas in the Democratic party, mentioning MMT as one of the backbones of her ideas. (I must admit I am not familiarized with most of AOC proposals, including the Green New Deal details).

Ever since then, there was an avalanche of criticism by economists, political commentators and almost everybody.

If you follow Twitter you probably have witnessed blood in certain debates.

Well, before you start losing interest on my post…

  1. I think MMT as a debate instigator for the economics profession is a breath of fresh air following the crisis “that nobody saw coming”.
  2. As someone that works at a central bank, I think it is essential their insistence on getting the operational details right (by accounting identities and T accounts) instead of focusing only on hard theory.

I would like now to offer my contribution to the “Great Modern Monetary Debate”.

Almost every criticism unjustly (as said before) starts by saying that MMT is a mix of “old and wrong ideas” and accept with this equation:

MMT= Lerner’s Functional Finance

Therefore I shall take that path too (while recognizing all the other MMT).

A sovereign government does not face financial constraints when budgeting, as a family does. To Abba Lerner the conclusion follows that the budget has the function of equilibrating the economy, reversing the “sound finance” policy prescription.

Afterwards, the government must “finance” its position with a composition of money and bonds. If it finances it by money, the interest rate will tend to fall, stimulating investment, leading to a smaller need of a deficit. This is the “crowding in” proposition, against the  mainstream crowding out theory.

Lerner then goes on saying that the public debt is only a reflex of macroeconomic factors. As Mosler puts it nicely the public debt is nothing more than an “interest rate maintenance account” as it is a reserve drain to all deficit spending.

What is different then between Lerner (and MMT) and the “Keynesian mainstream” (let’s say.. Krugman)?

  1. Lerner says that the government job is to pursue full employment by fiscal policy. Krugman wants central banks to follow a Taylor rule and only use fiscal policy when the central bank faces the zero lower bound.
  2. Lerner would say that deficit spending decreases interest rates, Krugman says that interest rates increase following deficit spending.
  3. Lerner says that government debt does not impose a burden on our children. Well.. Krugman agrees, but lots of other economists disagree (like Simon Wren Lewis, Nick Rowe,…).

My answers to these are:

  1. Scott Fullwiler explains (better than anyone else I can recall) that monetary policy works through changes in liquidity (by expanding reserves and/or deposits or by changing interest rates), fiscal policy works through changes in equity (private vs public) as a government deficit is a private surplus.
    1. Therefore, while fiscal policy “works directly”, monetary policy works by increasing liquidity and therefore stimulating private leverage (by either increasing money by debt or by increasing “velocity”).
    2. However, the “libertarian me” will say, indeed that is true. But monetary policy is fairer because it involves voluntary swaps of assets while fiscal policy envolves a combination of theft (taxes) and subsidies (gov. spending). Should we base macroeconomic management on so corruptible instruments?
  2. A government deficit means: more spending than taxes. Simply that.
    1. That means a net add of reserves on the banking system (coming from the Treasury account at the central bank). This addition to reserves puts downward pressure to short-term interest rates due to the increase in liquidity.
    2. That means a net add to private equity (saving) that may increase NGDP putting upward pressures on longer term interest rates.
    3. Usually the government “finances” the deficit by bond issuance, therefore sterilizing the liquidity increase (but not the increase in private equity). That neutralizes the short-term interest rates impact.
    4. The central bank MAY (should?) respond to the Government action by raising rates (I guess this is the Scott Sumner critique)
    5. But by the end of the day, one must conclude that Government spending corresponds ALWAYS (initially)  in an increase in the money stock (this stock may mean reserve balances and deposits depending on the cases).
  3. The debt burden…oh boy, this one is a hard one. Maybe next time? But I agree with Lerner. I think the sustainability issue is a “socio-political” and not economic.

I would like to add also:

  1. The “the government must spend first” and the “no overdrafts” debate is also very interesting. Scott Fullwiler’s work on this is great but I can simplify by saying:
    1. Imagine there are no excess reserves in the system. How can banks/private sector “finance” the government?
    2. If the Treasurys account is Zero, the way for the Government to issue debt (to deficit spend) is to have the central bank do a repo (temporarily expanding reserve balances)
    3. For more info about a country without bank reserves (Canada) check also Brian Romanchuck book “Understanding Government Finance”
  2. Also important is to classify as stupid all the criticism shouting Venezuela! Weimar! Hyperinflation! If a deficit is “funded” by bonds or money issuance is mainly irrelevant (at least today with IOER) as Scott and Stephanie wrote on the financial times once ago. (more on this in another post)
  3. The “taxes will tame inflation” debate also is something that I want to speak on. (Even though I know that taxes are not MMT’s favourite tool to fight inflation, but this works for every tool)
    1. Some criticism focus on the: So prices are rising and you want to raise taxes?
    2. I guess MMT here may form an unholy alliance with a completely different school of economic thought. Let’s see if you know who says this:

“Now suppose that, instead of saying inflation was too low in mid-2010, Bernanke had announced that we needed to boost the incomes of Americans in order to have a healthy recovery — and that the Fed would therefore try to boost the growth rate of national income from 4.3% to 6.3%. This message would have sounded much more appealing to the average voter than a call for higher inflation.”


Yap, I would say that MMT would gain by adopting a kind of NGDP targeting, to avoid supply/demand side inflation confusions led to criticism.


P.S.: To MMT scholars, I would really like to see a comparison between the Job Guarantee proposal and the Earl Thompson/David Glasner Labor Standard proposal.