The Civilized Money View (aka MMT, or Modern Monetary Theory) has historical precedents:

First, the notion—developed by Adam Smith—that the wealth of a nation is measured not by monetary values, but by its capacity to produce goods and services.

Second, the notion of money—developed by John Maynard Keynes—that any modern state claims the right to declare what money is.

While Smith’s concept hints to full employment as the primary policy objective, Keynes’s concept hints to the management of money as instrumental to reach such objective. Furthermore, MMT explicitly recognizes that the currency itself is a public monopoly.

This leads to an appreciation of the monetary system fundamentally different from the traditional Monetarist-Keynesian paradigm.

What follows is a summary of eight key differences between these two models: the Monetarist-Keynesian paradigm (MK) and the Civilized Money View (or MMT)

1.
MK – The central bank controls the money supply indirectly through its power to control the monetary base.

MMT – The private sector uses bank deposits as money, and bank deposits are not directly controlled by the central bank: they get created by government spending and bank loans.

2.
MK – Because the central bank controls the money supply, it also controls the nominal interest rate in the money market.

MMT – Because it is the monopolist of money, the central bank controls the interest rate.

3.
MK – The long-term nominal interest rate is determined by private preferences about real saving and investment, as well as by inflation expectations.

MMT – The central bank has the power to control the interest rate at any maturity: the interest rate is a purely monetary phenomenon.

4.
MK – A monetary expansion can expand output and employment temporarily and yet, at some point, it generates inflation.

MMT – Any operation by which the central bank buys or sells financial assets does not make the private sector any richer and has little or no consequence on private spending decisions.

5.
MK – Government decisions are largely driven by short-term personal goals of politicians, and thus the management of money should be the responsibility of an independent institution with a long-run horizon.

MMT – While monetary policy can only set interest rates, fiscal policy is much more powerful, since any deficit of the public sector generates an equivalent financial surplus of the private sector, and thus affects spending decisions.

6.
MK – Taxes serve the purpose of financing government spending.

MMT – Because government spending takes resources off the private sector and simultaneously generates income and wealth in the private sector, it will cause inflation from excess demand unless a sufficient amount of taxes is levied on the private sector.

7.
MK – If the government spends more than its tax revenue, it must borrow funds from the private sector, and this reduces funding to the private sector.

MMT – Unless it loses its power to define what money is, the government is the currency issuer: It faces no funding constraint, and it must spend or lend first, before the economy has the funds needed to pay taxes and buy government debt.

8.
MK – Price stability is a precondition for economic growth and job creation.

MMT – A government deficit of a size that matches the private sector’s desire to accumulate financial savings is a precondition for full employment.

This post is Creative Commons Attribution-Noncommercial-Share Alike 2.5 Switzerland License and I dare say any other country as well. It first appeared here via Franklin College’s Andrea Terzi.

I felt it was that important it had to be shared with a larger audience.  Of note is that the MK paradigm mentioned throughout is the traditional current orthodox neoclassical approach used in mainstream economics today.

1. Dollars are created when government (and their central banks) spend. Contrary to popular belief, governments DO NOT NEED to collect taxes or to borrow before they spend. They can simply create dollars from thin air.

2. Too much of the latter sort of “money creation” leads to excess inflation, and too little leads to households not having what they regard as enough money. So spending declines and unemployment rises.

3. It follows that attempting to balance the budget or avoid deficits or anything of that sort is a TOTAL AND COMPLETE waste of time. It’s pointless. If unemployment is excessive, government needs to create money and spend it (and/or cut taxes). Conversely, if inflation is excessive, government needs to do the opposite: that is, withdraw money from the private sector via a budget surplus, and “unprint” the relevant money.

(h/t Ralph Musgrave)

Originally posted here.

It could be argued it also a conversation with Noah Smith and Brad Delong. It is worth noting that Delong is getting closer to the MMT framework.

Wow, @delong just managed to explain MMT in 2 tweets; it usually takes 000s of tedious words twitter.com/delong/statuse… twitter.com/delong/statuse…

— Matt Cowgill (@MattCowgill) September 23, 2012

@noahpinion “MMT” is Abba Lerner (1944): that r < g with high probability forever, so set government spending at its 1st best share of GDP

— J. Bradford DeLong (@delong) September 23, 2012

@noahpinion and set taxes so the deficit is whatever gets you to full employment

— J. Bradford DeLong (@delong) September 23, 2012

In fairness this is as probably as close as you can get to the Neochartalist (MMT) point of view using the ISLM framework of Mundell Fleming.

There are a couple of catches (1) they think it is a special case that only applies near the zero-bound interest rate and (2) Neochartalism rejects the ISLM¹ model.²

In the words of one of the MMT founders, L. Randall Wray:

The MMT approach does not rely on ISLM. Its response is much simpler. With a sovereign currency, the central bank (Fed in our case) sets the overnight rate. Short term Treasury debt (ie “bills”, 30 day IOUs) are virtually perfect substitutes for bank reserves and so their rates should—and do—track the Fed’s rate target (fed funds) very closely.

What Delong, Krugman and Cowgill have done is try to fit a new framework into an existing framework and have been unable to make the paradigm shift for that reason.

Conclusion

If I wanted to summarise MMT in less than a few thousand tedious words I would emphasise as a general rule the private (non-government) sector desires to be in surplus and there are only three ways this can be obtained in only three ways.

Run a government deficit & a current account surplus
Run a government deficit > current account deficit
Run a government surplus < current account surplus

However, there is much more to it than that.

Further Reading.
Farther Reading.

¹ For this reason and many more
² Delong agrees with the flaws in ISLM but persists with it because “IS-LM is the simplest possible monetary model of the economy”

MMT called the meltdown more than a decade ago

— Australian MMTer (@AusMMT) February 2, 2012

Wray, Kelton, Parguez, etc. all saw”birth defects” in the institutional arrangements & predicted the widening of yields & ultimate crisis

— Australian MMTer (@AusMMT) February 2, 2012

h/t to @deficitowl for those last few tweets cc @pollytics

— Australian MMTer (@AusMMT) February 2, 2012

Worth noting Parguez is a circuitist ala Keen not MMT but add TCM & MMT together and you get a decent understanding of operational economics

— Australian MMTer (@AusMMT) February 2, 2012

This is not to say they were the only ones. No one claims otherwise.

Tom Palley came to the same conclusion in about 1997¹. Parguez allegedly came to the conclusion in 1986². Wynne Godley whom MMT borrows their stock-flow consistency framework came to the same conclusion in 1992 and with more detail in 1997. MMT persisted with the stock-flow consistent monetary modelling and claimed it often over the years.

Whilst there are many disputes over the optimal currency area of the Eurozone, as it turns out with no unified fiscal body this was always going to happen.    Getting it right is not about being able to say “I told you so,” but about having the credibility to say “here’s what should happen next”.  It is about being able to understand the monetary operations within the system. Sovereign currency is the key.

I highlight this to show stock-flow consistent modelling of MMT has its effective use.

Even @nytimeskrugman is coming around to MMT thinking bit.ly/xkrtHccc @andyshastings @pollytics

— Australian MMTer (@AusMMT) February 2, 2012

@ausmmt @andyshastings Roflol!

— Possum Comitatus (@Pollytics) February 2, 2012

Why this is cause for laughter I remain unsure. I shall attribute it to Possum’s infamous snark.

If it is in dispute of Krugman coming to this view with regards to MMT, through his NY Times Column and his Conscience of a Liberal blog he has been engaged multiple times on MMT. Like most he has had many misconceptions but they do seem to be dwindling over time. Krugman has been engaged with the expanding MMT community since at least 2010, many of the discussions can be seen here and here.  He has been getting closer over time and his recognition of the import of having your own currency is just the most recent.

Note the conservative mindset of those that fear change even those of the nominal left

— Australian MMTer (@AusMMT) February 2, 2012

(caveat: I reject left/right paradigm but use it for simplicity sake)

— Australian MMTer (@AusMMT) February 2, 2012

This is quite clearly me finally reacting to the snark.

@ausmmt Do you agree that MMT leads to higher inflation as a consequence of printing currency to fill your required level of demand?

— Possum Comitatus (@Pollytics) February 2, 2012

@pollytics I agree that there’s a higher level of inflation risk moderated by a nominal price anchor

— Australian MMTer (@AusMMT) February 2, 2012

@pollytics what measurement of inflation matters depends on real productive growth. Rate of 2-3% doesn’t tell us anything bout rest economy

— Australian MMTer (@AusMMT) February 2, 2012

@pollytics Take something like the JG (which I presume you’re referencing) out and all it does is describe exactly how the economy works

— Australian MMTer (@AusMMT) February 2, 2012

@ausmmt I actually can’t be bothered

— Possum Comitatus (@Pollytics) February 2, 2012

Finally Possum mounts an argument against MMT after much snark.

At the end of the day I was mistaken to reference a nominal price anchor and the Job Guarantee, not because it is bad policy but because I do not believe that is what Possum was referring. I had the JG – which is just a policy prescription based on the understanding of the MMT framework – on my mind and erred.

I do not agree that MMT leads to higher inflation, nor does it fill a required level of demand.  As Possum well knows one of the primary goals of MMT beyond a simple description of the economy and its operation is full employment.

So it is at this point Possum has invoked the NAIRU argument.  It is at this point we run into definitional problems of what constitutes full employment.  Possum is working on the hypothesis that is the NAIRU and MMT is working on frictional unemployment. Under frictional unemployment only the ill and those changing jobs and those that hold no desire to be employed are unemployed and much of that is temporary.

Now for the moment let us just assume that Possum is correct and the NAIRU applies, it involves deliberately keeping people unemployed.  It is fairly well understood that sustained unemployment imposes significant costs such as loss of current output, social exclusion & loss of freedom, skill loss, ill health and reduced life expectancy, loss of motivation & confidence, and much more.

This is what Possum prefers by invoking the NAIRU argument – social exclusion, harm and heartache.

In economic terms we call this hysteresis .  This only brings us back to Possum’s own argument:

@ausmmt @andyshastings MMT is like communism for the ideological purists – human behaviour be damned, I have an equation!

— Possum Comitatus (@Pollytics) February 2, 2012

Human behaviour be damned, I have an equation.  The NAIRU is an equation. One that prefers idle resources in idle labour (unemployment).

This brings us to inflation.  What is inflation?

Inflation is the continuous rise in the price level. That is, the price level has to be rising each period that you observe it. So if the price level or a wage level rises by 10 per cent every month, then you have an inflationary episode. In this case, the inflation rate would be considered stable – a constant rise per period.

Inflation occurs when there is chronic excess demand relative to the real capacity of the economy to produce.

So if we put the unemployed to productive activity (a job) there is little risk of inflation.

This is why I mentioned the Job Guarantee.

₁“European Monetary Union: An Old Keynesian Guide to the Issues,” Banco Nazionale del Lavoro Quarterly Review, 201 (June 1997), 147-164
₂La monnaie dans la crise (circa 1986)

@andyshastings It’s not adding to debt, meaning less has to go to interest repayments in the future and more to spend on other things

— Possum Comitatus (@Pollytics) February 2, 2012

@pollytics federal taxes don’t go into some magical pot that can be raided later, the money ceases to be. It’s a flow, not a stock.

— Andrew Hastings (@AndySHastings) February 2, 2012

@andyshastings a) they can and do b)repaying debt acts as an identical instrument- deferring expenditure

— Possum Comitatus (@Pollytics) February 2, 2012

Now there is a few things to unpack here.  One  is do taxes go somewhere to be spent later?  The quick answer to that is yes and no. The other is what is debt?

It is important to note that taxes are accounted for when paid.  If taxes are paid electronically, all that is done is your bank account is debited and the government accounts are credited.  No money has been created or destroyed it has been accounted for but for all intents and purposes it has been removed from the system – destroyed.

If taxes are paid in physical cash, it is destroyed after it has been accounted for.  However, if the cash notes are still in reasonable condition they will be recirculated as if NEW money.  So yes taxes destroy money but no they do not go into the magical pot for redistribution but it can appear that way given the recirculation of cash as if it is new.

On debt, the first thing to recognise is we are referring to government debt or federal debt.  Typically this refers to the issuance of government securities like bonds and includes the  government’s deficit.  It is important to recognise we are free of some of the constraints of the trilemma as discussed in the previous post and realise that the government does not have to get revenue from taxation or borrowing to “finance” its spending under a fiat currency system.

Since the government does not need to finance spending. The issuance  of debt by the monetary authority or the treasury has to serve other purposes as Andy Hastings highlights in the next tweet below.

Possum is correct to assert that a surplus does not add to debt and there is less interest to pay but that does not mean there is any more to spend on other things because the government issues its own fiat currency. The lack of debt issuance did cause some consternation in financial sectors when Australia ran a surplus.

@pollytics what? That’s not how fiat money works, man. Try: en.wikipedia.org/wiki/Chartalis… And the debt issue is a total red herring.

— Andrew Hastings (@AndySHastings) February 2, 2012

@andyshastings Oh please – that’s fringe dwelling nonsense, a sort of economic equivalent of creationism

— Possum Comitatus (@Pollytics) February 2, 2012

It is unfortunate that Possum, whilst known for his snark had to resort to an ad hominem attack here with no rebuttal. The attacks continue below.

@pollytics @andyshastings Principle 4 comes to mind: noahpinionblog.blogspot.com.au/2012/01/seven-…

— Matt Cowgill (@MattCowgill) February 2, 2012

#MMT = creationism? RT @pollytics: @andyshastings Oh please – that’s fringe dwelling nonsense, a sort of economic equivalent of creationism

— Andrew Hastings (@AndySHastings) February 2, 2012

Had this discussion before late September/early October with him @andyshastings

— Australian MMTer (@AusMMT) February 2, 2012

@ausmmt mmm, frustrating.

— Andrew Hastings (@AndySHastings) February 2, 2012

@ausmmt @andyshastings MMT is like communism for the ideological purists – human behaviour be damned, I have an equation!

— Possum Comitatus (@Pollytics) February 2, 2012

@pollytics @ausmmt if you say so…

— Andrew Hastings (@AndySHastings) February 2, 2012

Possum is correct to say it is fringe dwelling, largely unaccepted by mainstream economics but the empirical evidence stands on it own. On equivalence with pure communism or creationism, he is yet to make a case.

Beyond the insults Possum begins to make a point in line with the one Matt Cowgill made. However this is a misunderstanding and Possum knows it is not an equation, it is a macroeconomic accounting identity.

As in the previous post I pointed out that using the accounting identity is done in aggregate. It does not work for just me or just you or just you and me or just our neighbours, it takes into account every actor and that is where it takes into account human behaviour. That is the very next point I make.

@pollytics @andyshastings don’t U believ in stock-flow consistencey double-entry accounting its all bout human behavior bit.ly/pwxN5L

— Australian MMTer (@AusMMT) February 2, 2012

@pollytics @andyshastings Now Poss is no Austrian but its the Bob Murphy argument all over again.

— Australian MMTer (@AusMMT) February 2, 2012

The confusion lies in that Possum wants to represent MMT by the sectoral balances framework – as if that is the extent of it. MMT is ground in the operational realities that pertain to a modern fiat money system which is why I say the empirical evidence stands on its own.

As a matter of fact Government spending provides revenue to the private sector which then allows them to extinguish their taxation liabilities as I showed in the previous post. So the funds necessary to pay the tax liabilities are provided to the private sector by government spending. Many other insights can be derived from here. Many previously discussed in this very blog.

At the end of the day, MMT plugs in behavioural assumptions to this accounting identity. These assumptions are contestable but consistent with relationships that hold at the macro level.

For open economies (i.e. individual trading nations), the analysis can be extended to include external sources of revenue and expenditure. The accounting identity becomes:

(G – T) = (S – I) – NX

Here, NX denotes net exports (exports minus imports). In words, we have:

Budget Deficit = Net Private Saving – Net Exports

If we rearrange this expression, it becomes clear that there are now two possible sources of private domestic saving:

Budget Deficit + Net Exports = Net Private Saving

If domestic citizens sell more goods and services to foreigners than they buy in return, export revenue will exceed import spending and there will be a build up of financial assets. So, in an open economy, private net saving can come either from government deficit expenditure or net exports.

In many countries though, net exports are typically negative, which means the external sector subtracts from net private saving. This leaves the budget deficit as the only source of net private saving. For trade deficit countries such as the US, in other words, it is impossible for the private sector to net save (in aggregate) unless the government runs a budget deficit.

@pollytics which situation is that? Do you really believe that there is too much wealth in our economy at the moment?

— Andrew Hastings (@AndySHastings) February 1, 2012

@andyshastings There is never too much wealth in any economy. I can just see more benefits moving back to surplus now than costs

— Possum Comitatus (@Pollytics) February 1, 2012

@pollytics but that’s what a surplus does: destroys wealth. What benefits are there in a surplus now?

— Andrew Hastings (@AndySHastings) February 1, 2012

@andyshastings By no definition does a surplus destroy wealth. None, nadda, zip

— Possum Comitatus (@Pollytics) February 2, 2012

Now at first glance Poss could be forgiven for saying that a surplus doesn’t destroy wealth. However, he has made it clear we are not talking about real wealth, like shelter, transport, etc. but Net Financial Wealth but he has given that away at the outset by admitting he is pro-surplus.

There is somewhat of a misconception that a surplus is nothing more than reduced government expenditure as Greg Jericho indicates in this article.*

A more accurate definition would be where income is greater than expenditure. It is derived from a simple psychological basis where we are taught to view a surplus of things good and a deficit of things bad. It is just simple common sense isn’t it?

What the question doesn’t address is where those things came from in the first place. Now the origin of money has a checkered history but the only thing we are interested in is how it works today. There were some big historical events like the collapse of the gold standard and then the collapse of the Bretton Woods system, which for all intents and purposes was just a de facto gold standard and then in 1983 Australia floated the dollar. This freed it from constraints imposed by the trilemma.

This leaves the Australian government as the sole issuer (creator) of dollars – of fiat money.

By simple accounting identity what the government spends is what the private sector receives.  So logically as the issuer of the dollar, it has to go into deficit to spend.

(G – T) = (S – I)

This identity  shows an aggregate relationship that must hold by definition for a closed economy¹.

G is government expenditure, T is tax revenue, S is private saving and I is gross private investment. G – T, is the budget deficit. The right-hand side, S – I, is referred to as net private saving. It is the amount of disposable income that is not spent by the private sector.

This identity is true by definition and it is a familiar one to anyone that has ever studied economics as Poss has.

Another way of saying this is Budget Deficit = Net Private Saving (or net financial wealth if you prefer  – in MMT this is more commonly referred to as net financial assets).

So for the budget to go into surplus, you can see that Net Financial Wealth has to be reduced.

Budget Surplus = Negative Net Private Saving

Remember this is an accounting identity that measures in Aggregate. So what this does not mean is that people cannot save at all.  It means some will be able to continue to save money and some will be unable.

This does in fact show surpluses destroy financial wealth.  So Possum is clearly mistaken.

This is Andy Hastings very next point in the conversation.

@pollytics it’s the currency issuer removing more dollars than they are creating over that time period. Result = net negative.

— Andrew Hastings (@AndySHastings) February 2, 2012

^*I’m sure this is a misrepresentation of Greg Jericho’s intent but that is what it says in the article
¹I’ll extend this to an open economy argument in a follow-up post

It is so simple anyone can understand it.

According to the well-known trilemma,government can choose only two out of the following three: independent domestic policy (usually described as an interest rate peg), fixed exchange rate, and free capital flows. A country that floats its exchange rate can enjoy domestic policy independence and free capital flows. A country that pegs its exchange rate must choose to regulate capital flows or must abandon domestic policy independence. If a country wants to be able to use domestic policy to achieve full employment (through, for example, interest rate policy and by running budget deficits), and if this results in a current account deficit, then itmust either control capital flows or it must drop its exchange rate peg.

Floating the exchange rate thus gives more policy space. Capital controls offer an alternative method of protecting an exchange rate while pursuing domestic policy independence.

Obviously,such policies must be left up to the political process—but policy-makers should recognize accounting identities and trilemmas. Most countries will not be able to simultaneously pursue domestic full employment, a fixed exchange rate, and free capital flows. The exception is a country that maintains a sustained current account surplus—such as several Asian nations. Because they have a steady inflow of foreign currency reserves, they are able to maintain an exchange rate peg even while pursuing domestic policy independence and (if they desire) free capital flows.

Look at Cyprus!

Just in case that wasn’t clear enough, lifted from the same place:

Let us quickly review the connection between choice of exchange rate regime and the degree of domestic policy independence accorded, from most to least:

                *Floating rate, sovereign currency most policy space; government can “afford” anything for sale in its own currency. No default risk in its own currency. Inflation and currency depreciation are possible outcomes if government spends too much.

                *Managed float, sovereigncurrency less policy space; government can “afford” anything for sale in its own currency, but must be wary of effects on its exchange rate since policy could generate pressure that would move the currency outside the desired exchange rate range.

                *Pegged exchange rate, sovereign currency least policy space of these options; government can “afford” anything for sale in its own currency, but must maintain sufficient foreign currency reserves to maintain its peg. Depending on the circumstances, this can severely constrain domestic policy space. Loss of reserves can lead to an outright default on its commitment to convert at the fixed exchange rate.

Even here in Australia, regardless which side is in Government, we act like we’re on one of the latter two and we have not been since 1983.

You may wish to fast forward to the 5.00 minute mark.