Modern Monetary Theory


Modern Monetary Theory or Modern Money Theory is a heterodox macroeconomic theory that describes the nature of money within a fiat, floating exchange rate system. MMT synthesizes ideas from the state theory of money of Georg Friedrich Knapp and the credit theory of money of Alfred Mitchell-Innes, the functional finance proposals of Abba Lerner, Hyman Minsky's views on the banking system and Wynne Godley's sectoral balances approach. Economists Warren Mosler, L. Randall Wray, Stephanie Kelton, Bill Mitchell and Pavlina R. Tcherneva are largely responsible for reviving the idea of chartalism as an explanation of money creation.
MMT frames government spending and taxation differently to most orthodox frameworks. MMT states that the government is the monopoly issuer of its currency and therefore must spend currency into existence before any tax revenue can be collected. The government spends currency into existence and taxpayers use that currency to pay their obligations to the state.
MMT argues that the primary risk once the economy reaches full employment is demand-pull inflation, which acts as the only constraint on spending. MMT also argues that inflation pressures can be mitigated by increasing taxes on everyone, to reduce the spending capacity of the private sector, releasing real resources such that the state can employ them at current prices in a non-inflationary way.:150
The primary demand and inflation management approach advocated by most MMT economists is the job guarantee employer of last resort programme. This provides a spend-side automatic fiscal stabilisation mechanism and establishes a nominal price anchor, utilising a buffer stock of employed labour. This is in contrast to the orthodox monetary dominance approach to demand management which involves adjusting interest rates and utilising a pool of unemployed labour as a buffer against inflationary pressures following a belief in a Phillip's curve trade off between the two.
MMT is opposed to the mainstream neoclassical macroeconomic frameworks and has been criticized by many mainstream economists. In a 2019 survey of top U.S. economists not a single respondent agreed with the basic aspects of MMT. MMT is also strongly opposed by members of the Austrian school of economics. MMT's applicability varies across countries depending on degree of monetary sovereignty, with contrasting implications for the United States versus Eurozone members or countries with currency substitution.

Tenets

MMT's main tenets are that a government that issues its own fiat money:
  1. Creates money with any and all government spending
  2. Effectively destroys money via taxation
  3. Cannot be forced to default on debt denominated in its own currency
  4. Is limited politically in its money creation only by demand-pull inflation, which accelerates once the real resources of the economy are utilised at full employment
  5. Should strengthen automatic stabilisers to control demand-pull inflation, rather than relying upon discretionary tax changes
  6. Has the option to issue bonds as a monetary policy device or savings device for the private sector. Bonds cannot act as a means of funding public spending. The government can set whatever price for bonds it decides.
  7. Uses taxation to provide the fiscal space to spend without causing inflation and also to drive demand for the currency.
Tenets three to five of MMT do not conflict with mainstream economics understanding of how money creation and inflation works. However, MMT economists disagree with mainstream economics about the sixth tenet: the impact of government deficits on interest rates.

History

MMT synthesizes ideas from the state theory of money of Georg Friedrich Knapp and the credit theory of money of Alfred Mitchell-Innes, the functional finance proposals of Abba Lerner, Hyman Minsky's views on the banking system and Wynne Godley's sectoral balances approach.
Knapp wrote in 1905 that "money is a creature of law", rather than a commodity. Knapp contrasted his state theory of money with the Gold Standard view of "metallism", where the value of a unit of currency depends on the quantity of precious metal it contains or for which it may be exchanged. He said that the state can create pure paper money and make it exchangeable by recognizing it as legal tender, with the criterion for the money of a state being "that which is accepted at the public pay offices".
The prevailing view of money was that it had evolved from systems of barter to become a medium of exchange because it represented a durable commodity which had some use value, but proponents of MMT such as Randall Wray and Mathew Forstater said that more general statements appearing to support a chartalist view of tax-driven paper money appear in the earlier writings of many classical economists, including Adam Smith, Jean-Baptiste Say, J. S. Mill, Karl Marx, and William Stanley Jevons.
Alfred Mitchell-Innes wrote in 1914 that money exists not as a medium of exchange but as a standard of deferred payment, with government money being debt the government may reclaim through taxation. Innes said:
Knapp and "chartalism" are referenced by John Maynard Keynes in the opening pages of his 1930 Treatise on Money and appear to have influenced Keynesian ideas on the role of the state in the economy.
By 1947, when Abba Lerner wrote his article "Money as a Creature of the State", economists had largely abandoned the idea that the value of money was closely linked to gold. Lerner said that responsibility for avoiding inflation and depressions lay with the state because of its ability to create or tax away money.
Hyman Minsky seemed to favor a chartalist approach to understanding money creation in his Stabilizing an Unstable Economy, while Basil Moore, in his book Horizontalists and Verticalists, lists the differences between bank money and state money.
In 1996, Wynne Godley wrote an article on his sectoral balances approach, which MMT draws from.
Economists Warren Mosler, L. Randall Wray, Stephanie Kelton, Bill Mitchell and Pavlina R. Tcherneva are largely responsible for reviving the idea of chartalism as an explanation of money creation; Wray refers to this revived formulation as neo-chartalism.
Rodger Malcolm Mitchell's book Free Money describes in layman's terms the essence of chartalism.
Pavlina R. Tcherneva has developed the first mathematical framework for MMT and has largely focused on developing the idea of the job guarantee.
Bill Mitchell, professor of economics and Director of the Centre of Full Employment and Equity
at the University of Newcastle in Australia, coined the term . In their 2008 book Full Employment Abandoned, Mitchell and Joan Muysken use the term to explain monetary systems in which national governments have a monopoly on issuing fiat currency and where a floating exchange rate frees monetary policy from the need to protect foreign exchange reserves.
By 2013, MMT had attracted a popular following through academic blogs and other websites.
In 2019, MMT became a major topic of debate after U.S. Representative Alexandria Ocasio-Cortez said in January that the theory should be a larger part of the conversation.
In February 2019, Macroeconomics became the first academic textbook based on the theory, published by Bill Mitchell, Randall Wray, and Martin Watts. MMT became increasingly used by chief economists and Wall Street executives for economic forecasts and investment strategies. The theory was also intensely debated by lawmakers in Japan, which was planning to raise taxes after years of deficit spending.
In June 2020, Stephanie Kelton's MMT book The Deficit Myth became a New York Times'' bestseller.

Theoretical approach

In sovereign financial systems, banks can create money, but these "horizontal" transactions do not increase net financial assets because assets are offset by liabilities. According to MMT advocates, "The balance sheet of the government does not include any domestic monetary instrument on its asset side; it owns no money. All monetary instruments issued by the government are on its liability side and are created and destroyed with spending and taxing or bond offerings." In MMT, "vertical money" enters circulation through government spending. Taxation and its legal tender enable power to discharge debt and establish fiat money as currency, giving it value by creating demand for it in the form of a private tax obligation. In addition, fines, fees, and licenses create demand for the currency. This currency can be issued by the domestic government or by using a foreign, accepted currency. An ongoing tax obligation, in concert with private confidence and acceptance of the currency, underpins the value of the currency. Because the government can issue its own currency at will, MMT maintains that the level of taxation relative to government spending is in reality a policy tool that regulates inflation and unemployment, and not a means of funding the government's activities by itself. The approach of MMT typically reverses theories of governmental austerity. The policy implications of the two are likewise typically opposed.

Vertical transactions

MMT labels a transaction between a government entity and a non-government entity as a "vertical transaction". The government sector includes the treasury and central bank. The non-government sector includes domestic and foreign private individuals and firms and foreign buyers and sellers of the currency.

Interaction between government and the banking sector

MMT is based on an account of the "operational realities" of interactions between the government and its central bank, and the commercial banking sector, with proponents like Scott Fullwiler arguing that understanding reserve accounting is critical to understanding monetary policy options.
A sovereign government typically has an operating account with the country's central bank. From this account, the government can spend and also receive taxes and other inflows. Each commercial bank also has an account with the central bank, by means of which it manages its reserves.
When a government spends money, its central bank debits its Treasury's operating account and credits the reserve accounts of the commercial banks. The commercial bank of the final recipient will then credit up this recipient's deposit account by issuing bank money. This spending increases the total reserve deposits in the commercial bank sector. Taxation works in reverse: taxpayers have their bank deposit accounts debited, along with their bank's reserve account being debited to pay the government; thus, deposits in the commercial banking sector fall.