3 essential features in Modern Money

To understand how the modern monetary economy operates we need to take a step  into national accounting. First, a modern monetary system has three essential features:

  • A floating exchange rate, which frees monetary policy from the need to defend foreign exchange reserves).
  • A government which has a sovereign monopoly over the provision its own, fiat currency.
  • Under a fiat currency system, the monetary unit defined by the government has no intrinsic worth. The government makes no commitment to convert it, for example, into gold as it was under the gold standard. The viability of the fiat currency is ensured by the fact that it is the only unit which is acceptable for payment of taxes and other financial demands of the government.

Within a modern monetary economy, as a matter of national accounting, the sovereign government deficit (or surplus) equals the non-government surplus (or deficit), also known as the private sector (and here includes the international sector). The failure to recognise this relationship is the major oversight of the current orthodox analysis.

In aggregate, there can be no net savings of financial assets of the non-government sector (private sector) without cumulative government deficit spending. The sovereign government via net spending (deficits) is the only entity that can provide the non-government sector (private sector) with net financial assets (net savings) and thereby simultaneously accommodate any net desire to save and hence eliminate unemployment.

Additionally, and contrary to current orthodox rhetoric, the systematic pursuit of government budget surpluses is necessarily manifested as systematic declines in private sector savings.

The decreasing levels of net private savings which are manifest in the public surpluses increasingly leverage the private sector. Adopting a growth strategy that relies on increasingly leveraging the private sector is unsustainable.  So you have to trace the private indebtedness back to the conduct of the government sector.

The analogy current orthodox economics  draws between private household budgets and the government budget is false. Households, the users of the currency, must finance their spending prior to the fact. However, government, as the issuer of the currency, must spend first (credit private bank accounts) before it can subsequently tax (debit private accounts). Government spending is the source of the funds the private sector requires to pay its taxes and to net save and is not inherently revenue constrained.

With that in mind, modern monetary theorists develop a theory of unemployment based on the conduct of fiscal policy. In a fiat monetary system, unemployment occurs when net government spending is too low. As a matter of accounting, for aggregate output to be sold, total spending must equal total income. Involuntary unemployment is idle labour unable to find a buyer at the current money wage.

In the absence of government spending, unemployment arises when the private sector, in aggregate, desires to spend less of the monetary unit of account than it earns.

Steven Keen

Bill Mitchell


12 responses to “3 essential features in Modern Money

  1. Hi Mr. Senexx, sir!

    Thanks for the post. I’ve given it a quick read. It seems similar to Prof. Mitchell’s “Barnaby, better to walk before we run” (http://bilbo.economicoutlook.net/blog/?p=7864) .

    Let me check against Eladio Febrero’s paper and I’ll get back to you.

  2. Hi Senexx and Sean

    Sorry for the delay replying.

    I’ve been checking your text against Prof. Mitchell’s article (which I mentioned above) and against Eladio Febrero’s article. This gave me more details about the ideas exposed in the text.

    So, I suppose I can safely conclude that chartalism is not incompatible with the idea that banks also create money and that this bank-money may have its own dynamics (maybe a la Minsky and Keen).

    I imagine that the relative importance of both processes (Govt vs bank money creation) depends on empirical matters. This, for one, would allow for the Howard/Costello federal budget surpluses while the economy was growing: it is conceivable that this growth was financed with bank-money (that is, with an increase in private sector debt). In other words: the economy did grow, alright, but it was largely in spite of Howard and Costello and, in any case, financial capital made a lot of profits on that.

    This, as a side note, would suggest the possibility that, at least during the Howard/Costello years, corporate ROI may have been higher than usual.

    From Febrero’s paper, I also deduce that, because the EC has forfeited its ability to create Govt money (among other things, because there’s no EC central Govt), and instead has embraced full horizontalism, the recommendations of chartalism are largely out of the question for the EC.

    However, does this mean that the European countries can’t simply devalue the euro and let the lenders and bond holders to sustain losses?

    Further, even at the risk of some inflation in the short term, can’t the EC try to proceed with some further fiscal stimulus?

    Febrero seems to find that the notion of tax-driven demand for money is not realistic. I confess that the idea is slightly troubling to me; although I cannot find any logical flaw in it.

    Where I do have some real trouble is in the idea that the State controls the value of money. I’ll need more time to think about this. The way I figure, this statement does not preclude that the State could control the profit capitalists get: the Govt could offer an amount of numeraire for a unit of a manufactured commodity and an amount of numeraire for some unit of work. This way, it controls both final price of the commodity and price of labour.

  3. The illustration which comes up when you click on the X in a box, is of an Australian version game-board for “Monopoly”. The history of this game is very interesting because it was first devised by an economist of the 19th century who had read Henry George’s seminal work “Progress and Poverty” and designed the game to illustrate the Georgist theory. This was a kind of simulation before the days of computing. When it was first devised it was called “The Landlords Game” which is well worthwhile looking up on the internet. However it does not have much to do with fiat money!

  4. Regarding the basis for unemployment and money spending by the government, the details given above are not at all correct and the reason for there being unemployment is different. It is due to low demand for consumer and durable goods. This is because these items are too costly for many of them to find buyers. The monopolistic action of the big-scale manufacturers including their grip on the local availability of suitable sites where entrepreneures might otherwise compete, does not leave sufficient chance for prices to level off in a fully competitive society.

    Obviously it is a viscous circle which tightens as soon as worker are “let go” due to their lower demand for goods. Then these workers, having lower amount of earnings or limited savings, will further reduce their demand for the goods etc.

    Injecting more money into the system will not help. When a government does this the money is used to employ workers to improve the local surroundings of the community (the infrastructure including the amount of social help being given). This makes the land more productive and inevitably drives up its price, and that of its produce, etc. Thus the tax payers money is being used to create more unemployment!

    The way to break this paradox of rising land values and greater unemployment is to untax earnings and to collect the money instead from the potential productivity of the land. In other words all of the unearned benefit that speculators in land values would otherwise get plus much of the ground-rent. It would no longer be worthwhile to hold land out of use, because its potential productivity (opportunity) is being taxed. This is Henry George’s solution for creating greater equality of opportunity to work (and to live) and it is called Land Value Taxation, for which see: http://www.progress.org as well as HG’s own website.

    • Michael Hudson has expanded George’s ideas into economic rents in generally to take into account land rent, monopoly rent and financial rent. For a stable system, economic rent needs to be taxed away or reduced through institutional modification because it is parasitical and introduces inefficiencies. MMT recognizes this, too.

  5. Again you may find this link useful: http://neweconomicperspectives.org/2012/05/playing-monopolis-monopoly-an-inquiry-into-why-we-are-making-ourselves-so-miserable.html

    Also imagine you own land/property and are unemployed and a LVT is applied. That is why a LVT fails on its own two feet. It can work but it needs other policies supporting it. Also this seems to be the only proposal Georgist’s have.

    Also note in a non-monetary economy there is no unemployment and thus your reasoning is incorrect. Again I would elaborate if it wasn’t late.

    • David Chester

      Your answer is a contradiction in terms.
      Those with land have the means to work it. It is for those who are landless and have no chance to work that the concept of LVT will help. These are very much in the majority.
      Even in a barter economy, promises are made and promissary notes or time-limited money does exist. So you cannot seriously consider a moneyless economy. Even in something like this economy speculation in land values is possible and landlessness will results in unemployment.Your theorizing does not meet practical situations.
      Unemployment is due to land monopolies where useful land is not being used because the owner prefers to speculate in its growing value. This is downright harmful to the landless because it reduces the opportunity to find work whilst simultaneously making the competition for land availability more keen. Then production costs which include ground-rent, become raised, demand for goods becomes low and more unemployment follows!
      Land ownership can throttle economic progress.

  6. I’m sorry but owning a house (usually mortgaged) is owning land and if you are unemployed that does not mean taxing the land/house in anyway is going to help. So those with land do not have the means to work it. Perhaps you need a clearer definition of land. Perhaps you did not mean owner occupied homes.

    • We are talking here about an alternative taxation system to income tax, VAT, non-land property tax and capital gains tax. When these taxes are removed and LVT is substituted the prosperity of the community will grow by lwaps and bounds and there will not be any more unemployment. So when the new regime is fully applied there will be no problem with unemployment nor in paying mortgages. During the transition stages, as the changes are gradually introduced (which might takes as long as 10 years) there will be some unemployed people without ability to pay mortgages etc. A far-seing government will be prepared to grant these people some subsidy or deferment so that the problem is not so bad as you question implies.

      • You need to show the logic of these claims, which do not stand up on what you have presented thus far, but this is not the place to do it. I will give it a look.

        As suggested by Tom Hickey, please read or reread Warren Mosler’s 7 Deadly Innocent Frauds particular the sections about the role of Bonds (in Reserve Accounting) and Trade Deficits.

        I agree that minimising rents is a good idea.

        What is discussed on the blog is the way the system functions now.

  7. Warren Mosler supports a tax on land rents.

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