Introduction to Modern Monetary Theory

Dale Pierce just published the last part of a 3 part introduction to Modern Monetary Theory and while I quote Krugman when I think his policy prescriptions are useful (which is frequently) and frame most of my arguments from a NeoClassical (Samuelson) perspective (because then I don’t have to waste a lot of photons justifying myself), I’m increasingly attracted to MMT.

It’s fundamentally based on generally accepted principles of accounting (who says accountancy is boring) that have been around (documented) since the 1400s so in its own way it’s the Magna Carta of Economics.

Now what makes MMT “Modern” is that it assumes Government issued fiat currency (money) not associated with any particular commodity or fixed exchange rate (into other currencies).  A lot of intellectual energy goes into justifying that historically because so many people are emotionally invested in the concept that Gold or similar bright and shiny objects == money and that arbitrary currency inevitably leads to hyper-inflation (which is not inherently a bad thing provided wages and returns on capital investment keep pace).

Told you I was radical.

It is posted at New Economic Perspectives which I heartily advise bookmarking if you are into economic policy.  These are serious dudes with chops of the same sort as Friedman/Randian/Chicago School Monitarists and NeoLiberal/Rubinite/Salt Water Free Trader Globalists.

Modern Monetary Theory – An Introduction: Part 1

By Dale Pierce

Posted on April 22, 2013

MMT explores the monetary- and fiscal-policy implications (of) fiat-money. And this is, or should be, a politically neutral line of inquiry. We don’t have one monetary system for Democrats and another one for Republicans. However, there are few areas of policy disputation that are more hotly contested in America today than the ones MMT is most interested in exploring. The top three things that MMT seeks to explain are tax policy, the government’s budgetary and other other fiscal policies, and monetary policy. Enough said. Neutrality isn’t really an option when we will be addressing such unavoidably controversial subjects.

For Americans, the history the 1970s is painful history. a lot of people would just rather not think about it. But somewhere in the fourth year of a decade whose first year was all about Viet Nam, and whose final year witnessed the hostage-taking in Tehran, Richard Nixon completed the process he began with the suspension of convertibility of dollars for gold in 1971. Nixon “floated the dollar” on international currency markets. Except for people who were itching to speculate on gold, the public hardly noticed any of it. The experts said not to worry. And, sure enough, there were no noticeable effects for individual citizens – with the emphasis on “noticeable”. Behind the scenes, and in ways not even financial experts understood at the time, this change would change everything.

But initially – who really cared? Gold and dollars hadn’t been convertible for American citizens since a Depression-era measure which was passed way back in 1935. A provision of it banned the private ownership of any more than jewelry-size amounts of gold. People were glad to see that restriction go away – it was an affront to tell people what they could or could not buy, including gold. As for whatever central banks did with the stuff – well, what did they do with, or do about, anything?

Most Americans who think about it at all blame the Great Inflation of the 1970s on the introduction of fiat money back then. This was, after all, a core thesis of Milton Friedman’s monetarist, anti-Keynesian counter-revolution. His updated version of the Quantity Theory of Money had every conservative pundit with a working larynx intoning that “inflation is always, and everywhere, a monetary phenomenon.” Which, if you think about it, is much like saying that obesity is  always, and everywhere, a weight problem. But if anyone noticed the tautological or non-informative character of this generalization at the time, they either didn’t say so or were drowned out by the then-rising tide of Monetarism.

Friedman’s one-liner had a straightforward, common-sense appeal back then and it still does. And the monetarist story hangs together quite convincingly too, even on the first hearing. Prices are stable. Until they are destabilized by the dilution of the money supply with new fiat-dollars. Fractional reserve banking then kicks in, so most of the new dollars (up to 90%) get re-lent by banks, over and over again, as the money-multiplier does its dirty-work. In the end, a purchasing power many times as great as the original money injection is chasing the same goods that existed before – so, prices go up. Bada-bing.

Most of the people Modern Monetary Theory is trying to convince – educated Americans who think about the economy – have been exposed to, and believe, some version of this story. So, we don’t start from a level spot. We start from a situation where the conventional wisdom, for all but a few Americans, is that the Keynesian deficit-spending of immoral fiat-dollars always-and-everywhere causes inflation. And always carries the risk that it will accelerate into a hyper-inflation.

A very large majority of people unconsciously fail to distinguish between what is merely financial and what is real.

And here’s one way to think about the short-form narrative:

The private sector creates wealth and value – real wealth – real goods and services. Think houses, cars, dry-cleaning, corn-on-the-cob. The public sector creates money – obviously. Who else would create it? The private sector needs the government’s money to pay its taxes. The government supplies it by fiat-spending it into the economy, which also has the effect of moving real goods and services into the public domain. A government may do these things well or badly – efficiently or inefficiently – in ways that advance the common good or in ways that do not. But under our modern, fiat monetary system, this is the way things must work. It is the way they already do work every day. We just aren’t accustomed to thinking about them in this way.

Every day, the monetarist narrative on inflation is contradicted by the empirical evidence – as it has been for the past three decades and more. For if there is one thing absolutely everyone understands about the spending of the U.S. government today, it is that it spends vastly more than it collects in taxes. That is what deficit spending is. If the rate of consumer-price inflation really was, in any way, a straight-line function of the size of the government budget deficit, the inflation rate for 2008 and 2009 should have been spectacularly higher than in 2006 or 2012 – and much lower in 1998, when the Clinton administration ran the largest of its famous surpluses. The rate was about the same in all five of these years, and has rarely either exceeded four percent or been less than two percent in any year since the Great Inflation’s high-water mark in 1982.

People deal with the 30-years-and-counting absence of any significant amount of consumer-price inflation in a variety of ways. Some say monetarism just “worked”, and, for some reason, only had to work once. Some claim that the government is hiding the real inflation rate through accounting gimmicks or that T-bond sales somehow make the fiat dollars so illiquid, the deficits aren’t “monetized” (as if it was difficult or labor-intensive to sell a T-bond). Other people single out oil or some other commodity where monopoly power and speculation are the real price-drivers. Some then point to artificially created monopolies like health insurance and various forms of access to the telecommunications infrastructure. Even if the reason why a price goes up is monopolist power – or because Congress has granted rent-extracting opportunities to some well-connected lobby – many people will still lump that in with every other increase in their personal cost of living and label it “inflation.” And blame it on deficits, Keynesians and the national debt.

Modern Monetary Theory – An Introduction: Part 2

By Dale Pierce

Posted on April 23, 2013

The wave of capitalist triumphalism that spread around the world from the 1980s on was, and remains, a very complex social, political and economic phenomenon. Future historians, if there are any, will marvel at the suddenness of its rise and the completeness of its victory. Margaret Thatcher and Ronald Reagan seemed to come out of nowhere. Working class Tories and Reagan Democrats rose up in their millions – to vote against the very parties and ideas that had made them prosperous. And which had also made it possible for many of them to send their kids to college for the very first time. The kids themselves graduated into an economy plagued by inflation and full of uncertainties and unknowable quantities that everyone, everywhere seemed determined to blame on some English guy named John Maynard Keynes. Him and his Welfare State. And all that reckless deficit spending. And all those high taxes. Who wanted to be for things like Welfare and taxes? So, a lot of those kids went ahead and took the logical next step and became Young Republicans.

But the institutions of Keynesianism were, for the most part, and in the advanced world at any raate, very deeply entrenched. The Welfare State was unpopular as a concept, not as the set of  policies through which it was concretely expressed. These everyone took for granted and scarcely noticed – until some politician was foolish enough to take himself seriously, move from the general to the particular and actually oppose a program like Social Security. In such political moments, the shallowness and insubstantiality of the Right’s propaganda and political economy were briefly revealed. But if it was only an inch deep, it was still at least a mile wide. Large numbers of Democrats and other progressives, afraid of the wild rise in popularity of “free-market” economic ideas, rapidly adopted those same ideas themselves. They became “centrists” and later “deficit hawks”. But as they moved to the right to appease their newly conservative-minded constituents, the Right itself moved relentlessly to the far-far-Right, culminating in the all-out craziness of today’s Tea Party.

Ironically, Democrats and liberals found it easy to forget their Keynesian roots precisely because those roots were as deep and strong as they were. In all Western countries, and most Asian ones, there was some version of Social Security – and, as a rule, far stronger and more universal state-insured medical systems than in the United States. Institutionally, these and other safety-net programs looked unassailable – from unemployment benefits to welfare (or “the dole”), and even to state-paid child care in some countries. By the time of the Thatcher-Reagan “revolution” – it was really a counter-revolution – no one was seen as actively opposing the safety net. So liberals didn’t feel much need or obligation to defend it.

It is not the whole answer, but one big part of it is that “neo-classical” economics is, in at least one important respect, quite similar to the original. Like the Adam Smith version of Economics, (though unlike either Marxism or Keynesianism), the “neo-classicists” have very little interest in how we came to center so much of our economic activity around the getting and spending of money. For money itself is useless. Even money that is made out of silver or gold can only become useful by losing its status as money – i.e., by being melted down or hammered out or somehow otherwise made into something else – something that is no longer money. Some people like to look at coins, of course, and some also collect rare coins and notes. But their interest is in the incidental (and even accidental) characteristics of what they collect – the artwork, the state of preservation, and especially things that get printed or stamped incorrectly, and which are therefore rarities. Numismatists aren’t interested in the “money-ness”, per se, of their collections at all. And neither are “mainstream” neo-classical economists.

Whether they have used this terminology or not, classical and neo-classical economists have largely concerned themselves, not with money, but with utility – that is, with usefulness. People “truck, barter and exchange” things (to follow Adam Smith’s terminology) because, at any given moment, they have more use for some things than they have for others. And so, from the first paragraph of the second chapter of the very first Enlightenment-era economics text, we find a line of reasoning which minimizes and marginalizes money. (I.e., “The Wealth of Nations“).

Money is not even strictly necessary, this line of reasoning stresses. We could very well have an economy, (and there have been some actual economies) without any kind of money. In many versions, Robinson Crusoe and man-Friday  wander through the narrative at this juncture, colorfully haggling over the price of fish relative to coconuts and vice versa. And so on, through unknowable centuries and millennia of pre-historic time (this Economics says), humanity trucked, bartered, exchanged – and groped for a better way to do business.

Different universal commodities were tried – from cattle to salt to circular stones so big no one could lift them. What tribe or culture first chanced upon the advantages of the precious metals is lost in the mists of time, but the advantages persisted and metal money was born. It was imperishable, portable, and uniform. It was ubiquitous enough to be found everywhere but still rare enough to represent value in a concentrated way. In short, it was perfect. As hunter-gathering and pastoralism receded and civilization commenced, gold, silver and copper coins became the markers of the new social wealth of the elites. The institution and the forms of metal money were then passed down, with the added force of tradition, all the way to modern times.

Apart from its being largely untrue as history, this very conventional classical account of the origins of money also suffers from the singular defect of saying nothing about the issuer of all this money. It offers no theory at all about the role of the state. Indeed, it is scarcely mentioned. This is very much in keeping with the neo-classical definition of Economics as the micro-examination of utility-maximizing behavior by individual “agents”. It is sometimes granted that these agents may be human beings, but this is regarded as largely unimportant and is rarely even mentioned. Money, having no utility, is unimportant to this version of Economics too – as are the institutions and operations of a country’s monetary authorities. Debt is another almost entirely ignored category for neo-classicists, as are the operations of banks, including central banks.

Modern Monetary Theory – An Introduction: Part 3

By Dale Pierce

Posted on April 24, 2013

The state’s money is a good store of value and a reliable medium of exchange because absolutely everybody needs at least a little of it. Even off-the-grid survivalists and doomsday preppers need it. Because when they pay for their hollow-point ammunition at Dick’s, or for their freeze-dried mashed potatoes at Costco, they not only pay for the goods – they also pay the sales tax. Now, Dick’s and Costco only take dollars or dollar-denominated credit anyway, but what makes the state’s money valuable is that every company has to collect the tax piece in dollars and cents – and pay dollars to the government at the close of each week or month or other accounting period. Between sales taxes, property taxes, income taxes and all other taxes, everyone knows that there will be a stable, long-term demand for the currency which the state alone can issue. If this currency is reasonably well-managed by the country’s monetary authorities, it will remain everyone’s preferred legal tender – unless a person really is a survivalist or some other kind of crank.

The federal government spends by crediting private bank accounts, creating U.S. dollars in real time, by fiat, when it does so. Almost every single dollar the U.S. government has spent since a day back in mid-1971 has been created in exactly this way. (Exceptions include those famous went-missing-in-Iraq pallets of hundred-dollar bills we learned about later. The oddness of the example makes the main point that much stronger). The federal government doesn’t have or need a hoard of dollars stored away somewhere. Money is almost entirely a set of spreadsheets now. Such money is just electrons. Just zeros and ones stored in the computer databases of banks and central banks.

Since its spending is by fiat, the U.S. government doesn’t have to collect taxes or borrow from the Chinese to get money to spend. The function and true effect of taxation in a fiat money economy is to regulate aggregate demand. (the bonds are for interest-rate management). Taxes destroy some of the fiat dollars the federal government creates when it spends. They don’t “go” anywhere. They just disappear from private bank accounts. When we pay our taxes, there are a few fewer zeros and a few fewer ones in our particular spreadsheet cell in our bank’s computer. That’s all. The rest – the receipt, essentially – is a formality. The U.S. government is not more able to spend another dollar after we have been debited a dollar. It is not less able to spend after someone is credited one. And this account of the matter is not theoretical or, to the operatives who actually run the banks, in any way controversial. This is just the way the banking and central banking system works every day. Completely routine.

The thing modern fiat money preserves and improves upon is simple to say, but a little complicated to explain. It doesn’t yield easily to the gold-standard version of common sense. But it’s something anyone can understand if they try: one way of unlocking the mystery of money is to think of it as really just being a tax credit. Easy to say, but needs some unpacking.

This starts with understanding that the state, clearly, has no use for its own money – for its own I.O.U., one might even say. The things a government needs in order to be a government are mostly the same kinds of real goods and services the private sector needs – and produces. From jet planes to ink-jet printers to new printing presses for the national mint, the things government needs differ in only quite minor ways from the things individuals and firms sell to, and buy from, each other. But when the government buys them, it is a quite special case.

When the federal government buys something (or a state government does, spending federal dollars) the transaction has a completely different character than when an individual or a company buys something. In the latter case, existing dollars change hands – dollars which were previously spent into existence by the state. These dollars have been saved – set aside by someone in anticipation of some expected future need. But when the government spends, it creates new  dollars by fiat, ex nihilo or “from nothing”. It doesn’t draw them from some hoard or store. It never needs one. And these transactions are completely voluntary. Companies and other private-sector entities compete with the same energy and determination for sales to government entities as they do for any other category of sales. If anything, governments are even more desirable as customers – because they can always pay, and they virtually always do.

The conundrum of fiat money is why anyone takes it in return for their real goods and services. The economist Hyman Minsky once, somewhat famously, remarked that, “Anyone can print their own money. The trick is getting someone to accept it”. But if we think of the government’s I.O.U. as a tax credit – as a ready means of eliminating any private party’s obligation to pay a tax imposed by government, the mystery disappears. We could just as easily think of the tax – the real tax – as having been “paid” when we surrendered our goods or rendered a service to our government – in the first place. The fiat-dollars we receive in return can just as easily be thought of as records – recording the fact and magnitude of our real-goods transfers for future recognition by the government at tax time.

Neo-classicists represent borrowing as a contrast between “patient” individual agents, who are willing to wait for the things they want, and “impatient” ones, who want immediate gratification. (Or who want to finance a new entrepreneurial venture). Interest is the price of impatience and the reward that patient agents are entitled to receive in return for waiting. Patient agents, (who are probably sentient humans) save money and deposit it in a bank. These savings are, thus, the “loanable funds” available to be borrowed at any given time. Even Paul Krugman talks like this (he’s a “neo-Keynesian” – i.e. a neo-classicist with a conscience, who therefore gives a damn whether the “agents” he studies live or die). Since our available “loanable funds” are limited – are a function of the patience supply – governments must take great care not to borrow too much of the patient agents’ savings, lest their borrowing come to “crowd out” impatient entrepreneurs seeking capital for new or expanded ventures.

Now, since it is a certified, bi-partisan Truth that “governments can’t create jobs – only the private sector can”, it follows that the one and only way for a country’s government to help employment and growth recover from a recession is to leave as many of the banks’ “loanable funds” un-borrowed as it possibly can. And the only politically viable way to do that is to spend less money. From this point of view, it doesn’t make much difference what part of the budget you cut (if this sounds like the Sequester, that’s because it sounds exactly like the Sequester). If the only cuts that are politically possible are random cuts, that’s still O.K. All you’re trying to do is leave more zeros and ones in the banks’ spreadsheets so that all those hordes of salivating, animal-spirited, would-be entrepreneurs will find enough of them waiting there to launch their piece of the Next Big Thing and thereby, finally, Create Jobs.

“Loanable Funds” is bunk, just like the Quantity of Money and all the rest of Whatchamacallit Economics. Deposits don’t create loans – loans create deposits. Banks don’t lend out deposits, and they obviously don’t lend out reserves. Their loans just confer purchasing power on borrowers, along with debt. Modern Monetary Theory calls this bank-created credit “horizontal” money-creation [Primer Link] to distinguish it from the “vertical” money-creation only the state can engage in. Private debt and credit “net to zero” – they cancel each other out, so to speak. But looking at the way banks and central banks actually operate renders the entire framework of “loanable funds” absurd. This justification for austerity in a recession is – or should be – laughable.

The U.S. budget deficit has not “crowded out” any private borrowing, because that’s not how money, banking and credit work in the real world. And since nothing was crowded out – since their was no bidding war for access to the patient peoples’ limited stash of dough – U.S. interest rates went down, not up, in the years that saw the biggest deficits. And Zimbabwe? Core consumer price inflation remains all-but-undetectable as we continue to flirt with an austerity-induced second-dip recession eerily like the one Franklin D. Roosevelt induced in 1937. By following exactly the same kind of bad, deficit-hawking advice we are getting from “moderates” and “centrists” today.

OK, so it might be a 4 part “Trilogy”.  Sue me.

1 comment

  1. ek hornbeck

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